Dave Wage was a panelist at the Biz Times M&A Forum in March. The former CEO of Formrite shared his thoughts and experiences about the recent sale of his business.
As I recall it, Dave’s overall selling experience seemed positive – until the topic of the working capital adjustments came up, at which point Dave got a little quieter. He shifted in his chair, and the broad smile he’d been flashing shrank into one of those “I could have/should have known better” smiles.
In my experience buying and selling my own companies, I’ve had that uncomfortable smile too. Because, like most entrepreneurs and business owners, I didn’t fully understand what a working capital adjustment is or was and that’s never a great place to be when you’re dealing with such an important – and potentially costly – component of the overall take home value of your business.
Let’s start with the basics.
What is working capital?
In simple terms, working capital is the difference between your current assets and current liabilities. It’s the cash available for day-to-day operations of your business. Think of it as your business’s short-term health indicator.
Current assets are items like:
- Cash and cash equivalents
- Accounts receivable
- Inventory
Current liabilities are items like:
- Accounts payable
- Short-term debt
- Other immediate obligations
Why working capital is important
Working capital fuels your business. You inventory cash when you get paid for your product or service, and you burn cash when you pay your employees, suppliers and others. Usually, you maintain an inventory of cash that significantly exceeds your burn rate because things happen. Customers don’t pay on time, things break unexpectedly, stuff like that. Without excess working capital, the business can find itself in an uncomfortable cash squeeze.
When you decide to sell your business, the buyer will scrutinize your working capital like a detective on a crime scene. They want to ensure the business can sustain itself post-acquisition without additional cash squeezes or infusions. The buyer attempts to mitigate this risk by insisting on a working capital adjustment, which can lead to a minefield of disagreements.
Why? Because sometimes we hear what we want to hear.
For example, the buyer tells the seller that they will buy the company for X on a cash-free/debt-free basis subject to a working capital adjustment that will happen, for example, three months after the sale. When the buyer says these words, they mean that “the business will not need a post-close cash infusion.”
The seller hears the buyer say that they are paying X for the company and from that X amount, the seller must pay off the business debt BUT gets to keep all of the excess cash, meaning the difference between current assets and current liabilities. The seller hears “all the cash left over will be mine.”
Same words with very different understandings means trouble ahead
Although this is a frequent issue, it’s also unnecessary and avoidable. When planning to sell your business, it’s crucial to get yourself and your business prepared long before you accept an offer. You need to get educated about what to expect and get help from experts to make sure you know what’s coming and how to prepare for it.
When it comes to working capital, put on your buyer’s lens. Realize their motivations aren’t to screw you, but to make sure that your business will perform as expected, right out of the gate. With that perspective, begin looking at ways to decrease the working capital cash cushion your business needs to operate efficiently.
- Set a working capital expectation for the business
- Collect your receivables faster
- Match your payable days to your receivable days
- Write off uncollectable receivables now
- Remove excess, unneeded cash from the business
The final word
Working capital might not be the most glamorous part of running a business, but it’s one of the most important. It’s like the engine oil in your car – you don’t see it working, but without it, you’re not going anywhere. So, start educating yourself about working capital and its implications on your business sale now. Being prepared will not only make the process smoother, but also ensure you get the maximum value for your business.
