Franchise opportunity - Seller asking for inventory and AR estimate

July 13, 2024

by a searcher from Texas Tech University in Austin, TX, USA

I am looking at currently operating multi-unit franchise opportunity in the distribution space. The franchisor is a nationally well recognized and expects a certain level of inventory to be maintained always that can be between 0.5M to 1.5M. The current franchisee owner (Seller) is maintaining this level of inventory

Since seller has already given an inventory estimate and AR estimate dollar values. What are the possible ways to plan for working capital determination and final true-up?

Just a FYI, The business is around 12M revenue and overall valuation against the cash flow and including the high inventories/AR is acceptable,

Reply by a professional
from The University of Georgia in Atlanta, GA, USA

Options on working capital "target" or "PEG" setting are to 1) use average levels of inventory and A/R for the last 3, 6 or 12 month period, or 2) set inventory target at levels dictated by the franchisor and A/R using avg balances, though you will want to not accept any A/R over 90 or 120 days given collections risk. As a buyer, try to err on the side of asking the seller to provide as of a level of working capital as possible, thus, when they deliver less, they will need to "make good" on the shortfall. As far as final true up, you'll want to include provisions in the purchase agreement as the Buyer to calculate the actual working capital delivered at Closing (you will do it as you now own and control the books) and then compare against the target agreed upon in the APA and settle the difference. Generally the funds flow will call for set aside of some proceeds as escrow to cover any shortfall by seller that can be used in final settlement. Understand that working capital "true ups" can be the most contentious and controversial of the entire process, despite the concept being relatively straightforward. You'll want to ensure the purchase agreement details accounting methods used in the above determination. Hope this helps.

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