Anonymised, illustrative composite. A packaging distributor's supply agreement guaranteed a minimum annual purchase whether or not the business needed it. The company had never once used the full amount, and the shortfall it paid for was invisible on the balance sheet.
At a glance
The target distributed packaging materials and had, three years earlier, signed a five-year supply agreement with its principal vendor to secure pricing and guaranteed capacity during a period of tight supply. The agreement fixed an annual minimum purchase commitment of $1,400,000. If the company took less than that in a year, it still had to pay the vendor the difference in cash — a standard take-or-pay structure.
The buyer was acquiring the company by share purchase, with a conventional cash-free, debt-free pricing structure: an enterprise value set on a multiple of EBITDA, adjusted to an equity price by adding cash and subtracting debt and debt-like items at closing.
The company's actual demand for the vendor's product had never come close to the $1,400,000 minimum. Usage ran around $850,000 a year, and the shortfall payment — roughly $550,000 annually — had simply been paid each year and booked to cost of goods sold, indistinguishable in the financial statements from ordinary purchases. There was no separate line item, no note calling it out, and no balance sheet liability, because under ASPE an unconditional purchase obligation of this kind is not recognised as a liability until the obligation to pay actually crystallises period by period — it is, at most, a commitment disclosed in the notes, and this target's notes did not disclose it.
Four years remained on the agreement. The buyer's own production plan, which consolidated volume from a second facility being closed, meant the company's usage would stay at roughly the historical $850,000 level, not grow into the commitment. The shortfall payment was not a one-off; it was a predictable, contractually fixed cash outflow for the whole remaining term, regardless of how the business actually performed.
Annual minimum purchase commitment $1,400,000; realistic ongoing usage approximately $850,000; guaranteed shortfall payment approximately $550,000 a year, for four remaining years — $2,200,000 undiscounted.
Present-valued at the deal's own borrowing rate of 8%, used consistently elsewhere in the financing for the transaction, the four years of guaranteed shortfall payments came to approximately $1,850,000. Deducted dollar-for-dollar as a debt-like item in the closing adjustment, rather than folded into the EBITDA run-rate and multiplied, it reduced the equity price by that amount directly.
No statute or accounting standard dictates how a take-or-pay shortfall must be treated in a purchase price. The question the diligence team had to answer was a classification question, not a legal one: is this an ordinary executory contract — a forward commercial arrangement whose cost simply flows through future operating results and gets captured, if at all, through the multiple — or is it debt in substance, a fixed and non-cancellable payment stream independent of the business's own performance that belongs in the same bucket as a bank loan?
The distinguishing features here were that the shortfall payment is fixed in amount, runs for a defined remaining term, and is owed whether or not the company buys anything at all from anyone else in the meantime — the company is free to source packaging elsewhere and simply pays the vendor regardless. That combination is what puts it on the debt side of the line rather than the ordinary-course-risk side: a normal supply contract's cost varies with how much the business actually needs; this one does not.
The parties agreed to treat the present value of the guaranteed shortfall as a debt-like item in the closing statement, reducing the equity price by approximately $1,850,000. The purchase agreement's definition of “Indebtedness” was amended specifically to capture “any fixed, non-cancellable minimum purchase or take-or-pay obligation under a supply or service agreement, valued at the present value of the remaining guaranteed payments,” closing the gap for any similar item diligence had not yet found.
The seller argued, unsuccessfully, that the shortfall was an ordinary operating cost that belonged in the EBITDA run-rate rather than a dollar-for-dollar price reduction. The buyer's position held because the obligation survives regardless of the business's output — the defining trait of a debt-like item — where an ordinary supply cost would simply shrink if the business bought less.
If the shortfall had been left inside EBITDA and priced through the multiple, its effect on the purchase price would have been valued at the multiple applied to its annual impact on earnings — a very different number from its actual present value as a fixed obligation, and one that assumes the market will keep paying a multiple for a cash outflow that is not going to shrink. Worse, treating it as an ordinary operating cost rather than a closing adjustment would have left the buyer paying full price today for a liability it will still be paying down four years from now, on top of whatever multiple was applied to the earnings that liability was already suppressing.
The tell was in the general ledger, not the balance sheet: the shortfall payments were there, buried inside cost of goods sold, but nothing on the balance sheet or in the notes flagged a forward obligation. The only way to find it was to read the supply agreement itself, line by line, and notice that the minimum purchase commitment did not move with the company's own consumption. A liability that only shows up in a contract nobody asked for in the first data room pull is exactly the kind of thing a standard financial-statement review will not surface on its own.
A 30-minute call is enough to tell you whether AI pays for itself here.
Canadian small-business transaction data is not published anywhere, so most valuations in this country quote an American benchmark. The Deavo–Treadstone Acquisition Index is a daily record of Canadian listings built to replace that: asking-price distributions by province and city are published now, and days on market, departure rates and asking-to-sale spreads follow as the series lengthens. Leave an email and we will tell you as each measure lands.
No pitch, no listings. One email when the first report lands.
