Working capital in a business sale

A purchase price negotiated months before closing is built on a snapshot of the business that is already out of date by the time the deal actually completes — receivables get collected, inventory gets sold and replenished, bills get paid or accumulate. Working capital is the mechanism a purchase agreement uses to handle that gap, and of everything in a Canadian small business sale agreement, it is consistently one of the most heavily negotiated and, after closing, the most heavily disputed. Understanding how it actually works before you are staring at a true-up statement you disagree with is worth far more than understanding it for the first time in the middle of an argument.

Why working capital needs its own mechanism at all

A buyer is not just paying for the business’s assets and earning power — they are also paying, implicitly, for the business to arrive with enough short-term liquidity to keep running normally on day one, without an immediate cash injection just to cover payroll or restock inventory. A seller, meanwhile, has every incentive in the weeks before closing to let receivables run down, delay restocking, or stretch out payables, since anything left inside the business at closing effectively becomes the buyer’s. The working capital mechanism exists specifically to prevent that mismatch, by pegging the business to a normal, representative level of working capital rather than whatever balance happens to exist on an arbitrary date.

Setting the peg before closing

The peg is typically calculated from the business’s historical average working capital over a defined prior period, on the theory that a trailing average smooths out seasonal swings and gives a fair, representative baseline rather than a single snapshot that could be unusually high or low. Getting the peg calculation methodology exactly right, and agreeing on it in detail before closing rather than leaving it to be worked out afterward, is where a surprising amount of the real negotiating happens — a business with meaningful seasonality, in particular, needs a peg that reflects the time of year closing actually falls in, not a flat annual average that happens to misrepresent the specific month.

What actually gets counted

The purchase agreement defines exactly which line items count toward working capital, and that definition matters more than it looks like it should on a first read. Accounts receivable, inventory and prepaid expenses typically sit on one side; accounts payable and accrued liabilities typically sit on the other, but exactly how each is valued — whether aged or doubtful receivables are discounted, how inventory is counted and priced, whether certain liabilities like an owner’s discretionary items are excluded — is negotiated specifically, not assumed. A definition left vague at signing is a definition both sides will interpret in their own favour once real money is on the line at closing.

The true-up after closing

After closing, the buyer’s accountants prepare a closing-date working capital statement using the same methodology agreed to in the purchase agreement, and that actual figure is compared against the peg. If actual working capital comes in below the peg, the purchase price is typically reduced by the shortfall; if it comes in above, the seller is typically paid the excess. This adjustment usually happens through a holdback or escrow set aside specifically for this purpose at closing, so the money needed to true up the price in either direction is already available rather than requiring a separate payment demand weeks or months later.

Why this is the most common source of post-closing disputes

Working capital disputes are common precisely because the mechanism sits at the intersection of accounting judgment and real money, applied by a buyer’s team that now controls the business and has every incentive to interpret ambiguous line items conservatively. A receivable the seller considered fully collectible might get written down by the new owner’s accountant. Inventory the seller counted generously might get recounted more strictly. None of this necessarily reflects bad faith on either side — it reflects the fact that working capital, unlike a headline purchase price, is not a single agreed number but a calculation performed independently after the relationship between buyer and seller has already become adversarial in exactly the way negotiations before closing were not.

How disputes over the number actually get resolved

Purchase agreements typically build in a specific dispute process for exactly this scenario: the seller reviews the buyer’s closing statement within an agreed window, raises objections to specific line items, and if the two sides cannot agree, the disagreement is referred to an independent accountant acting as a neutral expert rather than to a court, with that expert’s determination on the disputed items being final and binding. Agreeing on this referee mechanism, and on which specific line items would even be arbitrable, before the dispute exists rather than after, is what keeps a genuine working capital disagreement from becoming a far more expensive and much slower legal fight.