When the Working Capital Peg Was Set From the Wrong Season

The situation

Jasleen had worked as an office manager for a distribution company for nine years after moving to Canada, and she had spent most of that time learning how the business actually ran, not just how the spreadsheets described it. When Fernanda, the owner of a Cornwall auto parts distributor, decided to retire, Jasleen saw her chance to buy something of her own. Her sister Ines, a registered nurse, agreed to co-sign the loan that would cover part of the purchase price, and together they worked with a business broker to negotiate a deal for roughly $1.1 million.

The business sold auto parts to independent repair shops across the region, and like most distributors, it lived and died by its inventory and receivables. Jasleen came to Treadstone Law once the broker had a signed letter of intent, wanting the purchase agreement drafted properly before she committed her savings and her sister's credit to the deal.

The deal structure itself was straightforward: an asset purchase, with the purchase price built around a target level of working capital — the cash, inventory and receivables the business needed on hand to keep operating, net of its payables. Buyers and sellers agree on this figure because a business can be stripped of cash and stock right before closing, leaving the buyer with an empty shell dressed up as a going concern. If the seller pulls cash out and lets inventory run down before handing over the keys, the buyer still pays full price for a business that can no longer serve its customers on day one. The purchase agreement set a working capital target and provided for a post-closing true-up: an accountant would compare the actual working capital on the closing date to the target, and whichever side came out ahead would pay the difference to the other. Jasleen understood the concept going in. What she did not fully appreciate, and what almost no first-time buyer does, is how much the outcome of that comparison depends on which historical period gets used to set the target in the first place.

The problem

The dispute traced back to how the target itself had been set. During negotiations, the seller's broker had proposed a working capital target based on the business's average balance sheet over the trailing twelve months. That sounded reasonable in principle, but the underlying data told a more complicated story. The distributor's slowest month for inventory was typically late winter, when repair shops cut back on parts orders and the business ran leaner stock levels than at any other point in the year. The seller's broker had pulled the trailing-twelve-month average from a period that happened to include two consecutive slow winters, because the prior owner had deferred a planned inventory restock during a cash crunch the year before.

Jasleen's team had negotiated the target based on that average without fully appreciating how much it understated what the business normally carried. Three months after closing, the seller's accountant delivered a true-up calculation showing that actual working capital at closing had been meaningfully higher than the target — largely because Jasleen, running the business normally through the fall, had restocked inventory to levels the seller's own average had never captured. The seller's position was simple: Jasleen had received more working capital than she paid for, so she owed the difference. The claim came to just under $140,000.

Jasleen was in a genuinely difficult spot. The math on the true-up mechanism, taken at face value, supported the seller's number. But the target itself had been built on two anomalously low months, not on what the business actually needed to run. Paying the seller's claim in full would have meant paying, in effect, for the seller's own prior cash-flow problems that had nothing to do with the business Jasleen had agreed to buy. Making it harder still, the loan Ines had co-signed left little room in the household budget for a six-figure surprise so soon after closing, and Jasleen was reluctant to go back to her sister with news that the deal she had vouched for now carried an unplanned cost.

What we did

1. Reviewed the purchase agreement's working capital mechanism line by line. The agreement specified how the target was to be calculated and by what method the closing figure would be measured, but it also included a clause requiring both figures to be calculated on a basis consistent with the seller's historical accounting practices. That clause became the centre of the argument: if the target period itself reflected an accounting anomaly rather than the business's normal course, the consistency requirement cut against simply accepting the seller's average at face value.
2. Assembled the underlying inventory records. We worked with an accountant to pull monthly inventory and receivable balances going back three years, not just the twelve months used to set the target. The pattern was clear: the two months included in the target-setting period were the lowest inventory months in the entire three-year record, roughly 30 percent below the three-year monthly average, tied to a documented restock deferral the prior owner had made for unrelated reasons.
3. Opened negotiations rather than proceeding straight to a dispute mechanism. The purchase agreement provided for an independent accountant to resolve true-up disagreements if the parties could not agree, but that process would take months and cost both sides accounting and legal fees regardless of outcome. We proposed direct negotiation first, presenting the three-year inventory data and the consistency clause as the basis for a reduced claim.
4. Framed a compromise that reflected shared responsibility for the flawed target. Neither side had caught the anomaly during due diligence, and both had signed off on the target-setting method. Rather than arguing Jasleen owed nothing, we proposed a revised working capital true-up using a smoothed twelve-month average from the three-year data, excluding the two anomalous months, which produced a claim closer to $45,000.
5. Negotiated payment terms that protected Jasleen's cash flow. Even at the reduced figure, paying a lump sum three months after closing would have strained the business while it was still finding its footing under new ownership. We negotiated a structured payment over nine months rather than a single payment, tied to the business's operating cash flow.

The outcome

The seller agreed to the reduced figure rather than pursuing the independent accountant process, which would have cost both sides several thousand dollars in fees with an uncertain outcome and no guarantee of a result closer to either side's number. Jasleen paid roughly $45,000 over nine months instead of the seller's original demand of just under $140,000, a reduction of close to $95,000 from the initial claim. It was not a result where either side left entirely satisfied — the seller had genuinely expected the full true-up amount, and Jasleen had genuinely believed no adjustment was owed at all — but it reflected what the underlying data actually supported once both sides looked past the headline calculation.

The business itself continued operating normally throughout the dispute, which mattered more than either party said out loud. A drawn-out fight over the independent accountant process would have consumed months of management attention during exactly the period Jasleen needed to be learning the operational side of a business she had never run before. The settlement let both sides close the file and move on.

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