Working Capital and Impact to Valuation

March 06, 2024

by a searcher from Georgia State University - J. Mack Robinson College of Business in Atlanta, GA, USA

I'm excited to join this community to share and learn from one another. I started this journey a few months ago and I'm looking forward to networking with many of you.

As it relates to Working Capital I understand that it can be included or excluded depending on the type of buyer and size of the business. When the price is >$5M and the buyer is a PEG, strategic investor, or search fund then the expectation is that Working Capital is included in the value. While businesses below $5m, with an individual buyer, and using SBA are excluding Working Capital. A few questions for the community:

1. is my above assumption reasonable?

2. thoughts on how to navigate the conversation with the Broker/Seller?

3. thoughts or approaches on how to value a business with or without NWC?

Further context: I'm reviewing an acquisition opportunity with an asking price of approx $5.5MM (3.5X SDE) which excludes NWC of approximately $1MM (+/- $200K depending on seasonality). I was looking to structure the deal with SBA/SN/Equity using 70/15/15 but the debt load is too heavy and ROE is not sufficient. I feel the $5.5M is a value that should include NWC and then the #s make sense. Would greatly appreciate any thoughts. Also, would appreciate any extra set of eyes on my deal structure and analysis so feel free to DM me if you can help.

Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

Even on smaller deals the purchase price should include a target working capital number. based on TTM or another timeframe. If they deliver more at close the price adjusts up dollar for dollar, if less than downward adjustment. #2 is the tricky question since even if the above is in the LOI, sellers often misunderstand what has actually been agreed and will attempt to have you pay for inventory, as one example. On the flip side you should be aware that there will not be any cash left with the business since most deals are cash-free. #3 not really in my wheelhouse but I've heard buyers say that for smaller sellers they always price the deal assuming no WC since they expect sellers not to grasp the mechanic fully, even if it's in the LOI.

Reply by a searcher
from The University of Texas at Austin in Scottsdale, AZ, USA

NWC in small deals is maddening b/c you can never get a straight answer lol. I'm actually in the middle of something similar and just had a light bulb go off from your post... you said" I feel the $5.5M is a value that should include NWC and then the #s make sense"...you probably answered your own question. If the deal doesn't make sense for YOU walk away...if you need to include NWC to make it work for YOU do it. Sorry for the cheesy response but I've spent 3 weeks way over analyzing a similar situation. Funny how when someone esle asks the same question you see the answer more clearly. I hope this help...if it doesn't know that you just helped me...thanks!

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