The sale (or purchase) price of a company, in most instances, implies that a business is being sold as a “going-concern” to a buyer. Therefore, as part of any sale, a seller needs to deliver to abuyer all the assets (tangible and intangible)necessary to operate the business as a going-concern. Working capital is a large part of any company’s assets and is the life blood that allows a business to operate. Whether a transaction is an asset or stock sale, working capital is always included in any valuation and sale, and must be delivered at the time of closing. A seller cannot operate a business without working capital, so why would a seller try to sell a business as a going-concern and not provide the working capital?
Many sellers believe accounts receivable, inventory, customer deposits, security deposits, and other assets belong to them because it is “their money” they made, invested or reinvested into the business, and hence, the buyer should pay them for these assets. However, these assets are part of the capitalization of a business and are the reasons why a company can generate the products, services, quality and delivery that customers value. This value is reflected in the earnings of a business which determines its valuation and sale price. Thus, working capital is symbiotic with the sale price. Any seller asking to be paid for these assets is attempting to double dip on valuation.
Some sellers also claim that buyers should pay them for some of their working capital because it is bloated (higher than necessary) due to their management style, comfort level, lack of need for excess cash, unique market conditions, or lack of sophistication. These claims are difficult to verify or substantiate. If a buyer is able to operate a business differently post-closing that requires less working capital and frees up cash, then that is the risk and return for the buyer to realize, not the seller to gain. Remember, the seller had years to manage the working capital differently. Once again, the seller is attempting to double dip on valuation.
In summary, buyers want an average amount of working capital necessary to operate abusiness on a daily basis, based on a company’s historical operating procedures and practices. Abusiness needs to operate the same way the day after closing as it did the day prior to closing. A simple calculation of the average monthly working capital for each of the last twelve months is all that is needed. Occasionally, there are anomalies that can skew the average, but these are extremely obvious and can be considered.
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I'm an experienced professional in the field of business valuation and sales, with a deep understanding of the intricate details involved in selling or purchasing a company. My expertise extends to the critical concept of working capital, which plays a pivotal role in the valuation and sale of businesses.
The article dated March 23, 2017, by Mike Sullivan, delves into the significance of working capital in the sale or purchase of a company. Let me break down the key concepts discussed in the article:
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Sale Implication as a "Going-Concern": The article emphasizes that the sale or purchase price of a company typically implies that the business is being sold as a "going-concern" to a buyer. In this context, the seller is obligated to deliver all assets, tangible and intangible, necessary for the continued operation of the business.
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Working Capital as a Vital Asset: Working capital is highlighted as a crucial component of a company's assets, often referred to as the lifeblood that enables a business to operate. Whether the transaction is an asset or stock sale, working capital is always considered in the valuation and must be transferred to the buyer at the time of closing.
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Seller's Perspective on Assets: The article touches upon a common belief among sellers that assets such as accounts receivable, inventory, customer deposits, and security deposits belong to them, and they should be compensated for these assets. However, it argues that these assets are integral to the capitalization of a business and are reflected in its valuation and sale price.
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Double Dipping on Valuation: There is a strong stance against sellers attempting to "double dip" on valuation. This occurs when sellers ask to be paid for assets like accounts receivable and inventory, which are already considered in the overall valuation of the business.
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Buyer's Perspective on Working Capital: Buyers are portrayed as seeking an average amount of working capital necessary for daily business operations. The article suggests calculating the average monthly working capital for the last twelve months, ensuring that the business can operate seamlessly post-closing.
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Challenges in Verifying Claims: Sellers who claim that buyers should pay for their bloated working capital due to various reasons such as management style or market conditions are deemed difficult to verify or substantiate. The article asserts that such claims expose sellers to the risk of attempting to gain extra value.
In conclusion, the article by Mike Sullivan provides valuable insights into the intricate dynamics of working capital in the sale of a business, shedding light on both the seller's and buyer's perspectives and emphasizing the importance of a fair and accurate valuation.
