The Second Time Pensri Called, the Paperwork Still Was not Done

The situation

Pensri and Kittipong had known each other for almost fifteen years by the time she called our office again, first as coworkers at a hotel where he worked the front desk and she handled scheduling and administration, and later as something closer to informal business advisors to each other's side projects. When Pensri left to start her own company - an events and staging supply business that had grown steadily to somewhere between $250,000 and $1 million in annual revenue - Kittipong was one of the first people she told, and one of the few who saw the books.

He was not a shareholder or an officer. He had no formal role in the company at all. But he was the person Pensri called when something in the business worried her, and he was the one who, three years earlier, had sat with her through her first meeting with our office about a completely different matter and heard the advice she was given about her share structure - advice about keeping the paid-up capital account accurate as shares were issued, which at the time seemed like a minor administrative point compared to whatever else was on the agenda that day.

Pensri had not followed up. Not out of any decision to ignore it, she said later, but because the business kept moving and the paperwork kept not being the most urgent thing in front of her. She issued additional shares to herself the following year when she incorporated a second product line into the company, and recorded a stated capital figure for them based on what she optimistically expected the product line to be worth rather than what she had actually contributed in cash and equipment at the time - a number on the higher side of generous. It sat that way, uncorrected, for two more years.

Now there was a buyer: a slightly larger company in the same industry, interested in acquiring Pensri's business outright, with Chelsea representing the buyer's side through the early stages of due diligence. Pensri came back to us not because she remembered the old advice, but because Chelsea's lawyers had sent a due diligence request list, and one line item asked for a share issuance history reconciled against the company's stated capital account. Pensri did not know, off the top of her head, whether the two would match.

The risk we had to size

They did not match. When we pulled the company's corporate records against its financial statements, the stated capital account showed one figure, and the actual consideration received for the shares issued over the company's history added up to something lower - not a dramatic gap in absolute terms, but enough of a mismatch, in the low tens of thousands of dollars, to be the kind of thing that a careful buyer's lawyer would flag immediately and a careless one might use as a wedge to renegotiate price.

The risk had two layers. The smaller one was mechanical, though not quite as simple as it first looked: the account had been recorded higher than what Pensri had actually contributed, and correcting that under the Ontario Business Corporations Act meant a formal reduction of stated capital, not just a bookkeeping adjustment. A reduction requires a special resolution passed by at least two-thirds of the votes cast, and directors cannot authorize one at all if there are reasonable grounds to believe the company could not pay its debts as they came due afterward, or that the realizable value of its assets would fall short of its liabilities once the reduction went through. Pensri's company was solvent and the figures involved were modest, so the test was not a barrier here - but it was a real legal threshold the correction had to clear, not a formality to wave through on the way to a closing date.

The larger risk was about what the mismatch would look like to Chelsea's side if her lawyers found it before we disclosed it. A due diligence process is, in part, a test of whether a seller's own records can be trusted, and an accounting discrepancy that the seller's team had to be prompted to find, rather than one it disclosed proactively, tends to get read as a sign there may be other things not yet found. Pensri's deal was not large enough to survive a serious credibility hit at this stage; a buyer with other options could simply walk, or use the discovery to push for a lower price and a longer, more invasive review of everything else in the file.

There was also the plainer fact sitting underneath both of these: this was avoidable. We had told Pensri, three years earlier, roughly what needed to happen to keep the capital account accurate as she issued more shares. She had not disagreed with the advice at the time. She had simply not acted on it, and the gap between the record and reality had grown quietly in the background of a business that, from the outside, looked like it was doing everything right.

What we did

1. Reconciled the full share issuance history against the stated capital account to establish the exact size and origin of the mismatch, tracing it back to the second product line's share issuance three years earlier, where the stated capital figure recorded at the time was higher than what Pensri had actually contributed in cash and equipment - a gap that had simply sat on the books, unnoticed, through two years of otherwise ordinary bookkeeping.
2. Confirmed the actual consideration received for the mismatched shares using bank records, Pensri's own contemporaneous notes, and Kittipong's recollection of the conversations at the time, since the corrected capital account needed to reflect what had genuinely been paid, not a convenient round number chosen after the fact to make the numbers work - a distinction that mattered because the correction needed to hold up under scrutiny from the buyer's own accountants, not just Pensri and Kittipong's shared memory of a conversation from three years earlier.
3. Prepared a special resolution reducing the stated capital account to match the actual consideration received, and confirmed in writing that the solvency test the Ontario Business Corporations Act requires before any reduction was satisfied - that the company could still pay its debts as they came due and its assets would still exceed its liabilities - giving the company a clean, properly authorized correction with a paper trail behind it, rather than a quiet edit to the books that would raise its own separate questions if a careful reviewer noticed it later.
4. Drafted a clear disclosure summary for Chelsea's due diligence team explaining what the discrepancy had been, when it arose, why it happened, and exactly how it had been corrected, choosing to get ahead of the finding on the company's own terms, in the company's own language, rather than wait for the buyer's review to surface it independently and frame the story for them.
5. Advised Pensri directly on the cost of disclosure versus discovery, since her first instinct was still to hope the gap would simply go unnoticed, and the file needed her to understand plainly that a proactively disclosed and already-fixed issue reads very differently to a buyer than the same issue found unprompted by their own lawyers, who would have no reason to assume it was an isolated slip rather than a pattern worth digging into further.
6. Reviewed the rest of the minute book for similar gaps before the due diligence process went further, on the reasoning that a mismatch found in one corner of a company's records is a reason to check carefully whether the same habits produced others elsewhere, rather than assume the problem was contained to one issuance simply because that was the one the buyer's request list happened to ask about first.
7. Coordinated the timing of disclosure with the broader due diligence schedule, delivering the correction and summary before Chelsea's lawyers reached that specific line item on their own request list, so the company's side controlled how and when the issue was first presented rather than scrambling to react once Chelsea's own lawyers had already reached their own conclusions about it on their own timeline.
8. Walked Pensri through what the original advice three years earlier had actually asked of her, so the correction came with a clear picture of what routine compliance would have looked like going forward, rather than leaving her to guess at what to do differently after this transaction closed and the next set of ordinary corporate housekeeping questions inevitably arrived on someone else's schedule.

The outcome

The correction went in and the disclosure went out before Chelsea's team's own review reached the point of finding the mismatch independently. Their response was procedural rather than adversarial: a few follow-up questions about the correction itself, confirmation the special resolution had passed by the required margin and that the solvency test behind it had been properly documented, and no renegotiation of price tied to the issue. The due diligence process continued on largely the same timeline it had been running on before the gap surfaced, without the delay a more contentious discovery would likely have caused.

The mismatch itself was resolved cleanly - the stated capital account now matches the company's actual share issuance history, supported by a proper resolution and a documented record of what was paid and when. But the deal was not free of cost from the episode, and it is worth being plain about that. Pensri spent several weeks of the transaction timeline on a correction that could have been a routine administrative filing three years earlier, at a fraction of the time, cost and none of the deal-stage pressure she found herself under this time. She absorbed the professional fees for doing it, in effect, twice over, since the original advice had already been given and paid for once and simply not acted on.

Pensri raised the earlier advice herself, unprompted, partway through this file - she remembered, once the mismatch surfaced during due diligence, exactly the conversation where it had first come up three years before with Kittipong sitting beside her. She did not offer much of an explanation beyond acknowledging that she had let it slide amid everything else the business needed, and there was not one that changed the work still in front of her. The company sale proceeded, the capital account correction stood without further challenge from Chelsea's side, and the file closed with the gap fixed rather than carried forward, unresolved, into a new owner's hands.

What you can learn from this