Negotiating working capital is one of the most contentious issues in closing a deal. That's because determining the amount of sufficient working capital needed to fund ongoing business is a complicated exercise. Robert B. Moore, Partner, McGladrey LLP, has expertly summarized the issues is his white paper, "Negotiating Working Capital Targets and Definitions".
From the time a letter of intent (LOI) is received to completing a purchase agreement, working capital never stays static, but you still need to pinpoint an appropriate amount of working capital to be left in the company at closing. After all, a buyer is going to want more than enough, even if the seller is only interested in the bare minimum. Every dollar you can negotiate to reduce working capital at closing means an extra dollar in your pocket. Here's what you need to think about to strengthen your negotiating position.
What Type of Working Capital Does Your Business Have?A buyer is going to look at historical monthly financial information to determine the characteristics of working capital. Working capital can fall into the following categories:
- Seasonal Working Capital - At the time of a sale, working capital can be very different than it was when negotiations began or when the LOI was executed. Is the anticipated closing date of the deal during your slow or busy period?
- Growth Working Capital - As the deal proceeds, working capital keeps growing.
- Negative Working Capital - With negative working capital, there are often more discussions about some or all the cash being left in the business at the time of the sale.
- Erratic Working Capital - Working capital targets are even more difficult to establish when historical information is erratic. In this case, you will need to provide support to determine what's considered a "normal" level.
Supporting the Working Capital TargetWhen it comes time to sell your business, you will need to come to the negotiating table armed with facts and support to back up your position on your company's valuation. Focus your energies on the following areas when considering an appropriate working capital target:
- What is normal for the industry?
- What is working capital as a percentage of sales?
- What special terms cause the company’s working capital to vary from normal levels?
- How significantly does inventory vary on a month-to-month basis?
- Lack of sufficient receivable or inventory reserves
- Cut-off issues on an interim basis
- Individual accounts that should be excluded, such as accrued interest
- Missing accruals such as vacations, payroll, bonuses, warranty, sales allowances, etc.
Working Capital Negotiating PointA few areas that can be negotiated in the purchase agreement to reduce the likelihood of future disputes include:
- Working capital can only be adjusted downward (which favors the seller), not upward (which would favor buyers).
- Working capital is only adjusted if, at closing, it is above or below the target working capital by a set amount, for example, $250,000.
ConclusionThe white paper, "Negotiating Working Capital Targets and Definitions" is a great resources to explain the intricacies of one of the most argued areas in selling a business. It is a must read if you are in the throes of a transaction, or even if you just want to better understand working capital management.
About Robert Moore
Robert B. Moore has a broad accounting and consulting background, specializing in financial management services such as mergers and acquisitions, due diligence investigations, business valuations, financial projections, obtaining financing, profitability analysis and improvement, and other corporate accounting and finance matters. He has worked with clients of all sizes, and his engagements have involved financial transactions, including debt financing, private placements, asset securitizations, portfolio acquisitions, loan workouts, and company acquisitions and divestitures. Bob has extensive experience working as an advisor to management, bankers, buyers, sellers and attorneys as well as serving as an advisor or arbitrator in working capital disputes.