Selling Your Business? Does Net Working Capital Matter?

bio_johnscholhamerBy Ted Scholhamer | If you’re selling your business and it’s a decent size deal, a buyer (“buyer”) usually requires you to leave a sufficient amount of net working capital in the business so buyer doesn’t have to pony up more cash on day one to keep it running.

So what’s net working capital (“NWC”)?

NWC equals your current assets minus your current liabilities.  Basically what you need to run the business.  Simple.  Right?  Not so fast.

How much NWC do you have to leave in the business?

To make sure you leave enough NWC in the business, you and buyer will have to figure how much is enough.   $500k?  $1mm?  $2mm?  $10mm?

That dollar figure, also referred to as the “NWC Peg” or just the “Peg,” is highly negotiated.

The Peg is typically a 6- to 12-month average of your historical NWC.  If your business is seasonal, it might be a 12-month average.  If your business isn’t seasonal, it might just be a 6-month average.

There are various addbacks and adjustments to the Peg to represent how much your business really needs to operate.

For example, you may book a liability for deferred revenue and buyer wants a full deduct from NWC for it.  However, the cost for buyer to service that business after closing may be very little, so why should the entire amount of deferred revenue be deducted from your current assets in calculating NWC?

This is where a good i-banker, accountant or lawyer can provide value by helping negotiate the Peg for you, which translates into real dollars.

So we’ve agreed on the Peg and the way to calculate it, what do you do with it?

After closing and the dust settles, buyer determines how much NWC you left in the business at closing.

If you left less than the Peg, then you have to pay buyer the shortfall.

If you left more than the Peg, then buyer has to pay you the excess.

It’s important to make sure the parties document in the purchase agreement exactly what the Peg is, how it was calculated, and that buyer calculates NWC after closing the same way the Peg was calculated (or in some other agreed on manner).

If not, you could end up in a post-closing fight because buyer calculated NWC the way it wants, which could be very different from how you historically did it.  End result is a fight, legal fees, and you possibly owing a lot of money.

Even though a well drafted purchase agreement builds in a NWC dispute resolution mechanism, a fight’s still going to cost you (money and a headache when you should be relaxing on the beach!).

Do I make money off this?

NWC is meant to be neutral. It prevents you from accelerating receivables, stretching payables, stripping that cash out, and then leaving buyer with nothing to run the business.  Sellers that typically try to “game it,” usually don’t come out ahead.

Buyers are just trying to make sure they don’t have to pump more money into the business on day one to keep it running.

You just want to make sure you don’t have to leave more in than the business requires.  That’s your money that you should keep.

Moral of the Story?

When selling your business, NWC and NWC adjustments aren’t meant to be a big financial windfall for either party.  However, if not negotiated and structured properly, it can have severe adverse financial consequences for you.  Given the technical and financial nature of NWC and NWC adjustments, you need an i-banker, accountant and/or lawyer who’s done this before and can keep you out of trouble.

For more information, contact Ted Scholhamer.