Handling working capital in a transaction is an issue that is often difficult for sellers of middle market companies to come to grips with. While grossly oversimplified, in most cases, the practical definition of working capital for transactional purposes usually means the amount of the company’s accounts receivable less the amount of the company’s accounts payable. (Other items can be important from company to company including inventory, accrued compensation, and other amounts, but in most cases, A/R and A/P tend to be the drivers of working capital in most transactions.)
The reason that the issue is difficult is not that it is complex, but rather that it can feel “wrong” to a seller for a buyer to be buying the company’s accounts receivable and other short term assets. Often, sellers feel like the buyer is taking money that the seller has already earned.
The buyer’s perspective is that it wants to ensure that it is acquiring all of the assets necessary to operate the business after a closing. This includes whatever cash is necessary to continue the day to day operations of the company. A buyer does not want to purchase the company at closing and then have to contribute another sum of money to keep the company operational.
The reality is that virtually all deals include a provision for working capital. Typically, the buyer and seller agree that the purchase price will include an amount of working capital that is “reasonably sufficient” to continue to operate the business. This is usually calculated based on the historical use of working capital by the company – often over a period of the trailing 12 or 24 months. Then, at closing, the purchase price is adjusted upwards or downwards based on the amount of working capital actually in the company at closing compared to the target amount.Share: