Selling A M&A Level Deal in Tampa: Well you need to understand working capital as part of the sale.

When you sell a larger M&A level transaction you need to understand that the buyers have a expectation that you will be giving them working capital.  Here is how it works.

 

Working capital is a key figure in the sale of a business because it shows the buyer how much liquid operating capital they will have when they take over, which helps ensure the business can keep running smoothly. Calculating it in a business sale is slightly different from calculating it in normal operations because you are adjusting for any excess cash or debt that won’t transfer to the buyer. Let’s break it down:

1. Understanding Basic Working Capital

In general, working capital is calculated as:

$$\text{Working Capital}=\text{Current Assets}-\text{Current Liabilities}$$

where:

• Current Assets are assets that can be converted to cash within a year, like cash, accounts receivable, and inventory.
• Current Liabilities are obligations that need to be paid within a year, such as accounts payable, accrued expenses, and short-term debt.

Imagine a business as a shopkeeper. Working capital is like the money in the shopkeeper’s cash register plus inventory on the shelves, minus the bills they owe in the short term. It represents what they have on hand to keep the shop running day-to-day.

2. Working Capital in a Business Sale: The Adjusted Approach

When selling a business, the working capital figure needs to be “adjusted” to reflect what the buyer will actually take on. The main goal is to identify the “normalized” working capital amount, which is the typical level of working capital the business needs to operate smoothly.

Steps to Calculate Working Capital for a Sale:

1. Determine the Normalized Working Capital Requirement:
   • Look at past financial data (often 12-24 months) to establish an average working capital level.
   • For example, if working capital over the last 12 months ranged from $200,000 to $250,000, the normalized amount might be around $225,000. This figure helps define a “baseline” amount that the business needs for steady operation.
2. Exclude Non-Operating Assets or Liabilities:
   • Excess cash (cash over and above what’s needed to run the business day-to-day) is usually excluded. For example, if the business typically needs $50,000 in cash to run, but currently has $100,000 in cash, the $50,000 excess would likely be removed from working capital.
   • Debt and loans not being transferred are also excluded. For instance, if there’s a $10,000 loan, and the buyer won’t take this on, it should not be factored into working capital.
3. Calculate Adjusted Current Assets and Liabilities:
   • Take the current assets you intend to transfer and subtract any liabilities the buyer will assume.
   • For example, let’s say the business has:
     • Accounts Receivable: $80,000
     • Inventory: $70,000
     • Accounts Payable: $50,000
     • Accrued Expenses: $10,000
   • Then, the initial working capital would be:

     $$(80,000+70,000)-(50,000+10,000)=90,000$$

4. Adjust for Timing Differences or Seasonal Variations:
   • Some businesses are highly seasonal, meaning their working capital requirements fluctuate. For example, a retailer might need more working capital before the holiday season due to high inventory levels.
   • The buyer and seller may need to adjust the working capital target based on timing. If the sale happens in the off-season, they might agree on a lower working capital requirement.
5. Negotiate a Target Working Capital Level:
   • The buyer and seller will negotiate a “target working capital,” which represents a mutually agreed-upon amount that will be delivered at closing.
   • This target can be adjusted up or down based on the specifics of the deal. If the actual working capital at the time of sale falls short, the seller may need to make up the difference, or if it’s above the target, the seller might receive a credit.

Example Calculation in Practice

Let’s put all of this together with an example:

Suppose a company’s last 12 months show the following average current assets and liabilities:

• Accounts Receivable: $90,000
• Inventory: $60,000
• Accounts Payable: $40,000
• Accrued Liabilities: $20,000

The typical working capital is:

$$(90,000+60,000)-(40,000+20,000)=90,000$$

After discussions, both parties agree that $90,000 is a reasonable target working capital. If, at closing, the actual working capital is $85,000, the seller might have to leave an extra $5,000 in cash or reduce the sale price accordingly. If working capital turns out to be $95,000, the buyer may agree to pay an additional $5,000.

Final Points to Consider

• Working Capital Peg: This agreed-upon target amount at closing helps avoid disputes by setting a clear level.
• Adjustments at Closing: Since working capital fluctuates, the buyer may perform a “true-up” shortly after the sale, adjusting based on actual data.
• Impact on Sale Price: Any changes in working capital affect the final sale price or post-closing adjustments.

In summary, calculating working capital in a business sale involves identifying the core current assets and liabilities that will be transferred, normalizing this amount to ensure it reflects typical business needs, and setting a target amount that can be adjusted depending on the actual figures at closing. For more on business sales contact Tampa Business Broker Michael Shea at 321-287-0349 or email mike@tworld.com .