By Scott Bushkie
Over the years, I’ve surprised any number of clients, looking to sell a business, by telling them that working capital most likely would be included in the price of their company. Many of them believed that they would get to keep the cash and the account receivables on the books. After all, those were their sales—didn’t they deserve to keep them?
But buying a business is a little like buying a car. You don’t buy a vehicle and then tow it to the gas station so you can get the fuel to make it run. The gas is included.
The same goes for working capital. Buyers don’t want to get financing to acquire the company and then go back to the bank for another line of credit to keep it running. They’re going to look at what the business has historically needed to operate and negotiate that into the sale.
Working capital is defined as current assets minus current liabilities. For practical purposes the four main components are cash, accounts receivables, inventory and accounts payable. In most cases we are able to negotiate to keep the majority, if not all of the cash for our clients, however typically the other three are negotiated as part of sale.
Sometimes we see a situation where a good part of the working capital is actually tied up in accounts receivables. We see this often during a recession when many customers are slow to pay. When receivables are slow, the working capital required to operate the business increases.
In one recent example, one of my clients from Minnesota had an unnaturally large accounts receivable because one of his largest clients owed him $825,000. His relationship with the customer was very strong and the owner had no worries that the client wouldn’t pay. But numbers like that were throwing his working capital calculation out of whack.
A year from now if he were to sell the business, a buyer would look at those distorted averages and assume that was the amount of working capital needed to operate the business and would have negotiated accordingly. We would have had a challenge arguing otherwise.
On our advice, our client talked with the customer and asked to be paid. The owner believed he could make arrangements to reduce the amount without jeopardizing the business. He got the money owed, and the relationship remains intact.
Now, when it comes time to sell, he’ll essentially be putting an extra $825,000 in his pocket. The value of the company will be the same because most business are valued on a multiple of cash flow, but the buyer will require less money in working capital.
Business owners who are thinking about selling should look at other ways to trim working capital costs. Look at your accounts payable and determine if you could extend terms with vendors without damaging the relationships. Review your inventory and get it in line with what the business truly needs to operate, this includes selling off obsolete or slow moving inventory as this will have little to no value to a buyer. Tighten up these financial issues before a sale and you’ll receive exponential value in return.
Scott Bushkie is President of Cornerstone Business Services, a low-to-middle-market M&A firm. Reach him at 888-608-9138 or [email protected]