Smith Manufacturing Inc. — Asset Purchase (Sample)
Plain-English read
This sample reviews a $4.2M asset purchase agreement for a third-generation Ontario manufacturing business. The deal price is reasonable for the stated EBITDA. The agreement structure is the problem.
The most consequential terms are a working-capital adjustment with no agreed target, an indemnification cap that excludes a long list of fundamental matters from the cap, an earn-out tied to revenue rather than EBITDA over a three-year period during which you will be running the business, and reps and warranties that survive for 18 months on most items but indefinitely on tax, environmental, and title — paired with a small escrow that releases at 12 months. Together these create real risk that the headline price is not the price you actually pay.
This report flags four items as red flags, lists ten specific questions to negotiate before signing, and recommends a focused legal review of four sections rather than the entire APA.
What is going to crack under load
The $800K earn-out is tied to gross revenue thresholds over years 1–3 post-closing. Revenue earn-outs are easy to game by the seller, who has every incentive to push pre-close shipments and lock in revenue at the expense of margin and customer relationships. They are also misaligned: you can hit the revenue target while losing money. Pair this with the absence of any post-close operational covenants and the earn-out is effectively a deal sweetener with no protection on the buyer side.
The working-capital true-up at closing references 'a normalized level of working capital consistent with past practice' but does not define the target dollar amount in the agreement. The number is to be agreed prior to closing in good faith. In practice this becomes a six-figure dispute resolved against you under time pressure, because the seller has the books and you have the deadline.
The cap is 15% of purchase price ($630K) for general reps. But the agreement carves out tax, environmental, title to assets, organization, and authority from the cap — uncapped or capped at 100% of the deal. Standard. The problem: the carve-outs also exclude the basket and threshold mechanisms, so a single small claim under any of these heads creates immediate exposure with no de minimis filter.
Most reps survive 18 months. The escrow holdback ($420K, 10% of price) releases at 12 months. There is a six-month window during which a claim has to be made against the seller directly, with no escrow security. For an SMB seller likely to distribute proceeds to family members and trusts post-closing, the practical recovery on a month-13-to-18 claim drops sharply.
Obligation breakdown across the term
The headline price is $4.2M plus an $800K earn-out. The realistic net is closer to $3.6M after working-capital adjustments and likely escrow drawdowns. Do your modelling on the realistic number, not the press-release number.
Put these in writing before signing
- Q01Will you change the earn-out from revenue to gross-margin or EBITDA, with operational covenants protecting our control of the business post-close?
- Q02Can we agree the working-capital target as a fixed dollar amount in §2.6 today, based on the trailing twelve-month average?
- Q03Will you accept a basket and threshold on tax, environmental, and title indemnities (even at lower thresholds than general claims) so single small items do not trigger exposure?
- Q04Can the escrow window match the survival period of the reps it secures? At minimum 18 months on the general escrow, longer on the carve-outs.
- Q05Will the seller agree to a tail policy on environmental and on R&W insurance for the deal, and at whose cost?
- Q06Can we get an opening balance sheet AUP report from a Canadian accounting firm before close, paid for by the seller?
- Q07What is the seller's plan for distributing proceeds post-close? Will the seller agree to escrow an additional 5% for the longer-tail carve-outs?
- Q08Can you provide trailing 24 months of customer-by-customer revenue and gross margin so we can validate the earn-out targets?
- Q09What changes to the workforce, customer relationships, or supplier contracts have happened in the last 90 days that we should know about?
- Q10Will the seller execute a 5-year non-compete and non-solicit covering customers, employees, and the broader trade area, with reasonable enforceability provisions?
What to do next
- 01Bring this report to a qualified Canadian M&A lawyer for a focused review of §2.6, §3.4, §9, and §10.
- 02Engage your accountant to validate working-capital normalization and quality-of-earnings on a 12-month basis before signing.
- 03Get a written quote on representation and warranty insurance (R&W) for this deal size — premiums are 3–5% of coverage and can shift exposure off the seller.
- 04Build your post-close operating plan and confirm it is consistent with the earn-out economics. Re-negotiate if the two are misaligned.
- 05Do not sign without the working-capital target written in dollars. Engage M&A counsel before signing.
General business and document analysis only. Not legal, financial, or investment advice. Always consult qualified counsel before signing.