Accounts Receivable: best practices to mitigate risk of rapid AR collection
February 07, 2023
by a searcher from Pennsylvania State University in Philadelphia, PA, USA
Hi All - curious to understand strategies to address scenarios where AR is typical in a business.
Example: business has a typical AR lead time of 3 months. When purchasing the business, this AR will be critical to cover costs over the span of the first quarter post-acquisition. If the seller accelerates AR collections during the LOI period, the buyer may find themselves in a significant revenue slump immediately post-closing.
What are the best practices to mitigate this risk?
from Bishop's University in Moncton, NB, Canada
For example, 'on closing, the current accounts balance shall be $100,000 with current account balance being the total of Cash, A/R and prepaid expenses less A/P and customer deposits.' You base this on the company you're buying. Notice that inventory is not included as I like to treat that separately with another inventory level clause.
Hope this helps.
In an asset purchase, you need to figure out the working capital needs and either include a level of A/R in the purchase or exclde them and bring your own as others have stated.
Please note that normal Enterprise Value is inclusive of Net Normal Position in Working Capital and if you don't factor this in, you'll overpay for a business every time in an asset purchase.
I cover this concept in this video: https://youtu.be/X6L_dS2gRYs
from University of Virginia in Richmond, VA, USA
Working Capital: Accounts receivable will stay with the Company in a balance of at least $X greater than the balance of accounts payable. $Y of cash will be left with the company.
Conditions: The Prospective Seller shall have operated the Company until the closing in the ordinary course and consistent with prior practices, and no material adverse change shall have occurred. The Prospective Seller shall not engage in extraordinary transactions without Prospective Buyer’s approval including but not limited to: a) Disposal of assets; b) Materially increasing the annual level of compensation of any employee, or increasing, terminating, amending, or otherwise modifying any plan for the benefit of employees; c) Issuing any equity securities or options, warrants, rights, or convertible securities; d) Paying any dividends, redeeming any securities, or otherwise causing assets of the Company to be distributed to any of its shareholders; e) Borrowing any funds under existing credit lines or otherwise.