Working capital as a negotiated term

The short version

• Working capital is the cash, money owed by customers and inventory a business needs to run day to day, minus what it owes its suppliers.
• How much working capital stays in the business at closing is negotiated, and it changes what you are really paying.
• Many sales set a target amount. If the business has less at closing, the price usually goes down. If it has more, the price may go up.
• You also need your own working capital after closing. It can come from your cash, the loan or a separate line of credit.
• Settle the working capital terms in the letter of intent, not at the closing table.

What working capital is

In plain terms: what the business has on hand to keep running, such as cash, receivables and inventory, minus the bills it owes in the short term, such as payables.

A business that is sold with no working capital leaves the new owner to fund payroll and supplies from day one, before customers pay.

Two separate questions

1. What stays in the business at closing?

In many small business sales, the seller keeps the cash and the money customers already owe, and pays off the business's debts. You start with the inventory and equipment, but not the receivables.

In other sales, a set amount of working capital stays with the business. This is often called a working capital target or peg. If the actual amount at closing is below the target, the price goes down. If it is above, the price may go up.

2. Where will your own working capital come from?

Whatever stays with the business, you will likely need more to cover the gap between paying costs and getting paid. Your options:

• Your own cash, kept in reserve after closing.
• A lump sum inside the acquisition loan. This raises your loan payment.
• A separate line of credit alongside the main loan, drawn only when needed.

Lesson B3.1 covers these.

How to set a target

Look at the business's working capital month by month for at least a year. Many businesses are seasonal. Base the target on a normal level, not the lowest or highest month. Your CPA can calculate it.