Selling a Business – How to Deal with Net Working Capital
Selling a business is a lengthy process and often involves intense negotiations with regards to valuation, adjusted EBITDA, net working capital, and continued owner involvement among other items. Net Working Capital is one of the items that often gets contentious in a sale process.
What is Net Working Capital (NWC)?
In simplistic terms, NWC represents the liquidity of the Company, its ability to meet its short-term obligations and its operational efficiency. For transactions that involve buying or selling a business, NWC is defined as Current Assets (less cash) minus Current Liabilities (less debt). The reason cash and debt are excluded is that most transactions are on a cash-free and debt-free basis. This means the Seller keeps all the cash and pays out all the debt at the Closing of the transaction.
Is it included in the Offer Price for your Business?
A lot of business owners believe that the Offer Price is in addition to getting paid for Accounts Receivable and Inventory. This is NOT true. For transactions that are valued on Cash Flow / EBITDA metrics, Net Working Capital as defined above is INCLUDED in the Offer Price. Net Working Capital needs to be viewed as a company asset, the same as a piece of equipment used in the company’s operations. Both are needed to continue to run the business.
So, what is the appropriate amount of NWC that is included in the Offer Price?
The amount of NWC included in the Purchase Price is usually an average over time to account for the fluctuations in NWC. Generally, the NWC Target (amount to be included with the Purchase Price) is the average of the last 6, 12, 18 or 24 months depending on the growth, seasonality, cyclicality and type of business. For example, if the Net Working Capital is $1,000,000 based on the last 12-month average, then this is the Target Net Working Capital and the amount that the business should deliver at closing as part of the Purchase Price to the new buyer. There is typically an adjustment period of 60 to 90 days post-Close of transaction for any “true-up.” The Seller receives an additional amount to the Purchase Price if the NWC at Close is in excess of the Target NWC and the Seller has a Purchase Price deduction if the NWC at Close is lower than the Target NWC.
Are there any adjustments in determining Target NWC?
Yes. In determining normalized NWC, it is important to identify and remove any unusual, non-recurring and non-operating amounts from the historical balances, as well as any amounts that would be excluded from the definition of NWC in the purchase and sale agreement. Specific adjustments will vary by business but frequently include:
Aged Accounts Receivable
Obsolete Inventory
Non-recurring Accounts Payable
Related Party Transactions
Tax-related Transactions
Why do transactions fail due to Net Working Capital?
NWC to be included in the business is usually left to the end of most merger and acquisition processes and is often highly contested due to the intricacies involved in this calculation as described above.
How Can Distinct Capital Partners Help?
An experienced M&A advisor can help sellers navigate the negotiation process and ensure a fair and attainable Net Working Capital Target. The Distinct Capital Partners team has experience in working on hundreds of transactions and has encountered all types of situations related to Net Working Capital. One of the things we strongly recommend to our clients is to clearly determine the Net Working Capital Target and its calculation at the Letter of Intent (Offer) stage. At this point, the seller has the most negotiating power.
If you are considering selling your business in the near future, our team will perform a high level due diligence at no cost to you to ensure you are ready to sell your business.
If you are interested in learning more, please contact Gerard De Souza, Managing Director – Business Development at GDeSouza@distinctcapitalpartners.com or our general enquiry email at info@distinctcapitalpartners.com.