When the Working Capital Target Was Built From the Wrong Season

The situation

Femi and Abena had run a small licensed home childcare agency out of Oshawa for six years. Femi, a bookkeeper by training, handled the accounts and payroll; Abena, an early childhood educator, ran placements and managed the roster of home-based caregivers. Together they had built a modest but stable client base of local families, and when a competing agency of similar size came up for sale, they saw a chance to roughly double their book of business in one move without having to build a second client base from nothing.

The seller, Harpreet, had run the competing agency for over a decade and was retiring. The two agencies overlapped in the families and caregivers they served, and Harpreet was willing to sell the client contracts, the licence, the office equipment, and goodwill for roughly $520,000. Femi and Abena put together the purchase using savings and a small business loan, and the deal was structured as an asset purchase rather than a purchase of Harpreet's corporation, so that only the specific contracts, equipment and goodwill named in the agreement would transfer, and existing liabilities of Harpreet's company would stay behind with the seller. They brought Treadstone Law in to handle the purchase agreement before anything was signed, expecting a fairly routine review of a small business deal.

Where the target went wrong

Agreements for a business purchase of this size commonly include a working capital adjustment. The idea is straightforward: the buyer isn't just paying for a licence and a client list, they're paying for a business that should arrive with a normal, working level of cash, receivables and prepaid costs, net of what it owes. The agreement sets a working capital target — usually built from an average of the seller's own historical financials — and if the actual working capital on the closing date comes in below that target, the seller owes the buyer the difference, because the buyer would otherwise have to inject their own money just to keep the business running at a normal level. A portion of the purchase price is typically held back in escrow specifically to cover that possibility, so the money is already set aside rather than something the buyer has to collect after the fact.

When Treadstone reviewed the draft agreement during due diligence, one detail stood out. The proposed target of about $30,000 had been calculated from Harpreet's financials for June, July and August — the agency's quietest months, before the fall re-enrollment cycle. Closing, meanwhile, was scheduled for early October, right after that cycle. Every September, families paid a deposit or first month's fee to hold their fall placement. Until the caregiving was actually delivered, that money sat on the books as deferred revenue — a liability, because it represents a service still owed to a family, even though the cash is already sitting in the bank. A summer-based target simply never captured it, because in June, July and August there was no fall deposit money on the books yet. Using those summer numbers to measure an October closing date meant the target and the actual closing-date figures were never going to be comparable, regardless of how the business was actually performing. Left as drafted, the mechanism was likely to manufacture a dispute rather than measure anything real.

What we did

1. Flagged the mismatch before signing. We explained to Femi and Abena what deferred revenue was and why a target built from the agency's slowest three months would not line up with an October closing that fell right after the busiest enrollment period of the year. Femi, with his bookkeeping background, understood the accounting point quickly once it was framed in terms of deposits sitting on the books as a liability rather than income.
2. Tightened the definition and the dispute process. Rather than try to renegotiate the target itself against a seller who had no reason to agree it was wrong, we focused the agreement's language on precisely which accounts counted toward working capital — cash, receivables, prepaid supplies, minus payables and deferred revenue — and added a clause sending any post-closing disagreement to an independent accountant for a binding determination, instead of leaving it to open-ended negotiation between the parties if the two sides could not agree on the numbers.
3. Kept the escrow holdback large enough to matter. We held firm on an escrow holdback of $50,000, roughly ten percent of the price, specifically earmarked to cover a working capital shortfall so Femi and Abena would not be left chasing Harpreet for repayment after the fact if the numbers came in as expected, and would not need to fund the shortfall themselves in the meantime.
4. Prepared the closing-date financials on time. When closing arrived and the numbers landed roughly where we had anticipated, we worked with Femi to prepare the closing statement and delivered formal notice of the shortfall to Harpreet's lawyer within the strict window the agreement required for raising it.
5. Took the dispute to the accountant, not to court. When Harpreet's lawyer pushed back on the methodology, arguing the shortfall was overstated, we invoked the independent accountant clause directly rather than threatening litigation, supporting the claim with several years of Harpreet's own prior financials showing the same seasonal deferred revenue pattern recurring every September.

The outcome

The closing-date statement showed net working capital of roughly negative $18,000 — cash and receivables of about $37,000 against roughly $55,000 in prepaid tuition deposits collected that September, alongside the agency's ordinary payables. Measured against the $30,000 target, that produced a shortfall of about $48,000, a figure large enough that Harpreet's lawyer initially treated the claim as a negotiating tactic rather than a genuine accounting position.

The independent accountant's review, completed about seven weeks after closing, agreed with the core of the buyers' position: the target had been built from an unrepresentative period, and the shortfall reflected a genuine timing mismatch rather than any real decline in the business. The accountant awarded Femi and Abena roughly $46,000 from the escrow, releasing the remaining balance to Harpreet in recognition of a small set of pre-closing costs the seller had also incurred that were fairly attributable to the transition period.

Femi and Abena ended up paying an effective price of about $474,000 for a business that would otherwise have cost them the full $520,000 against working capital that could not actually cover the fall term's obligations. Just as importantly, the agency had the cash on hand to pay caregivers and run the fall roster without Femi and Abena dipping into their own savings or drawing further on their loan in the first months of ownership. Because the dispute went to a defined accountant process rather than a negotiation with no fixed endpoint, the whole disagreement was resolved in under two months, and the agency's day-to-day operations were never disrupted while it played out.

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