Anonymised, illustrative composite. Four million dollars of prepaid funeral contracts sat on the balance sheet as deferred revenue, with a matching investment asset beside it. Neither line was what it looked like. The money was held in trust for third parties, every contract was cancellable at will, and the margin was capped by the operator's own price list.
At a glance
Two funeral homes in a mid-sized Ontario city, run by a family that wanted out. Revenue $3,920,000, EBITDA $940,000, asking price $6,900,000. The buyer was a consolidator with eleven locations and a drilled diligence process.
A licence under the Act “is not transferable” (s.14(2)), so this had to be a share purchase. Diligence went where it usually goes: earnings quality, call volume, cremation mix, the fleet, the working-capital peg. The peg is where it went wrong. Deferred revenue of $4,060,000 was picked up as a current liability and prepaid trust investments of $4,180,000 as a current asset, netting $120,000 into the seller's column.
Prepaid funeral money is not a customer prepayment. s.52(1) provides that an operator receiving money in advance of providing licensed supplies or services “shall ensure that the money is held in trust if required by the regulations”, and O. Reg. 30/11 s.78(1) requires it, with one carve-out: from the 30th day the operator may retain, as not trust money, no more than it could deduct on a cancellation — under s.140(2), the lesser of 10 per cent and $350.
So the asset is not the corporation's. It is a fund the buyer takes over as trustee, with an accounting it must pass and an investment mandate it inherits. Under s.76(1) it must “hold all trust money separate and apart from all money other than trust money” and deposit it into a compliant account or pooled fund “not later than the 35th day after the day the operator receives the money”.
And the liability is not one the buyer extinguishes by performing at its own margin, because s.81(2) caps that margin. Despite anything in the contract, “the maximum amount an operator may retain under the contract in consideration for the provision of the supplies and services is the lesser of” the prepaid trust money and the current selling price on the operator's own price list at the time the services are provided. Anything left over goes to the purchaser under s.81(1) paragraph 2.
The work went contract by contract, because s.80(1) permits a pooled fund only where records “permit the tracking and reporting on funds in the fund on an individual contract basis”. The first finding was a funding gap no aggregate reconciliation would have shown. On 96 contracts worth $348,000, written across a 14-month management change, deposits were made after the 35th day s.78(2) requires, at worst four months late. The measure is not the days: on cancellation s.140(1) requires all money received plus the greater of income earned and “The income that would have been earned on the money had it been deposited as required under the Act and the regulations”. Reconstructed at the fund's own realised rate, the shortfall was $61,400.
The second was structural. The buyer had valued the book as any acquirer values a backlog: $4,060,000 at a 34% gross margin, $1,380,000 of future gross profit. Running s.81(2) across all 1,180 contracts at the current price list gave a different answer. On 812 the trust money had grown more slowly than the list, so the operator retains the trust money and absorbs the gap — $214,000. On the other 368 it had outgrown the list, so the operator keeps only the current price and $180,000 goes back to purchasers. Expected gross profit was $986,000, not $1,380,000. That gap is the shape of the rule: the operator carries the downside when the fund lags the price list and does not keep the upside when it leads. A buyer paying a multiple for contracted revenue here is paying for an option it does not own.
Part VI builds the trust; the regulation supplies the numbers. s.52 puts advance money in trust and provides that it and its income “shall not be paid out except in accordance with the regulations”; and s.57 constrains investment, providing that “no trustee shall make investments with money that this Act requires to be held in trust” contrary to the standard in s.27(2) of the Trustee Act. And under s.59(1) a person holding trust money who is directed in writing by the registrar or the Public Guardian and Trustee “shall apply to the Superior Court of Justice to pass the accounts of that trust fund or trust money” — an obligation the buyer inherits for a period it did not manage.
One provision is routinely described backwards. s.60 does not stop the licensee taking compensation out of the trust — s.81(1) paragraph 1 allows trust money to be paid to the operator as the services are provided. What it prohibits is charging the customer for the trust: “No licensee shall charge a purchaser of licensed supplies or services, or receive any compensation or payment from such a purchaser, for establishing or maintaining a trust fund or account”. Read backwards, it sends diligence at the wrong ledger.
The peg was redrawn to exclude the trust investments and the prepaid liability. They are not working capital but a fund held for third parties, and running them through a mechanism built for receivables and payables credited the seller with a $120,000 surplus belonging to purchasers — the necessary departure from how a working-capital adjustment works.
The $61,400 was funded into the trust by the vendor before closing rather than indemnified afterwards, because a trust deficiency is not merely a claim between the parties — it is a state of affairs a regulator can direct be accounted for. A specific indemnity for undiscovered deficiencies sat behind it, uncapped, surviving three years: see indemnity clauses in a purchase agreement. The price came down $340,000 on the s.81(2) recalculation against the $394,000 the model showed, the difference being a genuine disagreement about how fast the price list would move.
The real exposure was never the $61,400 or the $394,000, but that the book is not a backlog at all. Under s.44(1) the purchaser “may cancel the contract at any time” once the cooling-off rights have run and while the operator has not fully performed, and s.44(4) requires the refund within 30 days.
If 10 per cent of the book cancelled in the year after closing — 118 contracts, $406,000 — the buyer refunds that plus the income the money earned or should have earned, and retains at most $350 a contract: $41,300 against a $406,000 outflow. No notice, no penalty, no offset. A consolidator just through a rebrand and a change of local ownership is exactly the operator whose purchasers start reading their contracts.
The tell was the words on the balance sheet. “Deferred revenue” describes money the corporation has and will earn. Money held in trust for identified beneficiaries under a statutory scheme is not that. The label is not an error; it is the misconception, sitting in the account name.
The confirming document takes one request. Under s.106 the registrar must hold a current copy of every trust agreement the operator has entered into for prepaid trust money. Ask for it, and the trustee's statements, before the general ledger. If they do not reconcile contract by contract, the reconstruction has to be done anyway — before the price is agreed or after.
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