Yet another working capital question

January 30, 2024

by a searcher from Columbia University - Columbia Business School in Washington, DC, USA

Looking at a deal now where the seller is proposing an asset sale excluding the receivables. Roughly speaking it's a $2M deal plus $750 in inventory and $1.5M in AR. What are your thoughts on a deal this size without AR?

Without AR I worry about being able to fund the business on day 1 and getting a large enough LOC.

With AR, I would clearly need the ability to hold the seller accountable for obsolete receivables, given the amount. (thinking either escrow holdback or larger seller note)

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I always tell buyers that there are really two ways to look at a business acquisition from a working capital standpoint. The first is you are getting the business at a good price in which case you can expect to have to fund some or all of the working capital directly. The second option is you are paying full price for the business, in which case you should be getting the business with the working capital in place already to operate the business as you are paying full price for the business.

I see a lot of transactions where the seller wants the maximum multiple for the business and also wants to walk away with key assets like A/R and all of the cash, and also get paid for all of the inventory. The numbers typically do not work if the seller wants it both ways. Usually there has to be a give and take in the negotiations and if the seller is demanding everything then the deal typically will not work. Keep in mind, the money the seller is getting for the transaction is not just the price you are paying but is also any assets they are keeping. That is the all-in income they would be getting from the sale. Sellers will argue that all of the A/R and cash is their's, and certainly if there is excess A/R and cash a portion of it likely is their's. But at the end of the day the business with all assets only has so much value and there needs to be an adjustment made for what is needed to operate the business. The seller could not pull all of the cash and A/R out of the business and still have a viable business, so you should not be buying a business stripped of all assets that is not viable at day of closing.

What you need to do is figure out first how much debt can the business support? Can you afford to borrow the additional working capital outside to of the deal, or should you pay for the A/R you need to operate the business because you are getting it for a good price. If the business cannot support the debt you need to operate then there is a problem and likely you are over-paying for the business (total compensation being both what you are paying and the assets the seller is stripping out of the business).

You also need to figure out how much working capital the business needs to operate. Once you know what that working capital peg is, you can then negotiate with the seller to keep that much in assets in the deal to support it, Or if you are getting the business for a good enough price, you can pay for that amount of A/R or other assets to have the working capital you need to operate.

I hope this is helpful. If you would like to discuss further can you reach me here or directly at redacted Good luck with your search.

Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA

Tagging onto redacted‌'s comments, I am reminded of the old math property A + B = C, thus C - B = A. When NWC (B) is included in the price (C) the buyer is funding NWC through the acquisition loan. When NWC (B) (particularly AR/AP) is not included in the price (A) or the transaction, then the buyer is funding it with a permanent WC loan and/or LOC (lenders provide these regularly alongside the acquisition loan). When using multiples to determine if the price you are going to offer includes or excludes NWC, users must be aware of the NWC rules of the database. For example, PeerComps includes inventory but excludes AR/AP. DealStats is all over the board and you have to look at the detailed data set (all 199 columns) to determine if your comps include or exclude NWC (in a recent pull I did of 39 manufacturers, only 3 of the 39 included NWC in the calculation). So, just like you wouldn't apply an SDE multiple to EBITDA, you wouldn't apply a multiple that excluded NWC to come up with a price that included it without adding the NWC value to it. A + B = C, thus C - B = A.

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