Say Goodbye to Working Capital When You Sell

Let’s talk about your cash. Any normal business owner would tell you that their cash is in their bank accounts and their receivables, inventory, work in process, etc. Basically what they’re saying is that their cash is buried deep in the business, and it’s that cash that makes the business run. So if the business owner needs to come up with cash in a hurry, they’re likely to aggressively collect their receivables and slow raw material purchases etc.

The problem comes in when the business owner sells their company. What the business owner calls their cash, the buyer calls working capital. And if you look at a letter of intent it will say something like “we’re willing to purchase a cash-free debt-free business”. But the reality is that once your business gets over a few million in revenue, while this may be technically true, from the business owner’s perspective this may not be exactly true because there’s a high likelihood that the buyer will demand that you leave working capital on the table.

To simplify this further, let’s break your working capital into 2 categories: “Buyers Cash” vs. “Sellers Cash”.

 

Buyers’ Cash is your working capital, i.e. your receivables, accruals, inventory, as well as thankfully, your payables.

 

Sellers’ Cash is your “excess cash over and above reasonable working capital”.

But what is reasonable working capital? This can create a real problem and can lead to heated negotiations at sale time. It is entirely possible based on how you run your business today that you may be overfunding your working capital or underfunding your working capital, which in either case could be to your detriment. If you have competent advisors you should be able to negotiate the right amount of working capital that you will need to leave in the business, but by not planning in advance this can have negative consequences on your pocketbook.

Often the adequate working capital, also known as a working capital hurdle, is based on the average monthly adjusted working capital over a 12 month period. So if you generally keep more capital than needed in your business, you could be in a sticky situation if you don’t have the right advisors because you will have to explain to the buyer why the normal amount of cash you keep in the business is really an excessive amount of cash. On the other hand, the situation can be even more complex for high growth companies where typically their future working capital needs are much higher than the last 12 months. The amount of working capital you leave in the business is highly relevant to your future net worth and it should be something on your company’s planning radar today.

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