Working Capital: The Most Misunderstood Part of Selling a Business

Hey, it’s David

During a recent flight, I had a conversation with someone who was selling their company and was incredulous that he had to leave behind working capital as part of the transaction.

Here’s how the conversation went…

…don’t you expect the plane to be full of fuel?

I asked him why that was so upsetting?

His response was, “I should be getting paid for my business and I should get to keep all my working capital.”

My response, “When you rent a car, don’t you expect the car to be full of gas when you drive out of the rental car location? Do you think the airline we are flying today should sell us a ticket, then, when we board, collect more money for jet fuel?” 

Of course, his response was “No, that’s included in the price of the rental car or the price of my plane ticket.”

Well, it is the same when buying your business.

The buyer expects there to be fuel in the tank on the day they take over. The buyer does not pay you a multiple of EBITDA, then add more money to the deal to operate the business on day 1.

The buyer, by paying a multiple of EBITDA, is also buying your balance sheet, and therefore is acquiring your working capital.

When a buyer is considering purchasing your company, they expect the company to have a certain level of working capital in order to continue operating smoothly and meet its financial obligations.

The buyer will want to see that the company has enough cash, accounts receivable, inventory, and other current assets to cover its current liabilities. Some of the key components of working capital include:

• Cash and cash equivalents

• Accounts receivable

• Inventory

• Accounts payable

To determine your company's working capital requirements, you will need to consider how much of these assets and liabilities you will need to maintain to continue operating your business.

For example, if you operate a business that requires you to hold large amounts of inventory, your working capital requirements will be higher than a business that does not require a significant amount of inventory.

The quick math to determine your approximate working capital as you go into a deal is:

Current Assets – Cash -Current Liabilities

This quick calculation will give you a snapshot of how much you will potentially be required to leave behind as part of the transaction.

This is an area where many M&A transactions run into trouble simply because the Seller does not understand how deals are structured and they have the erroneous thought that even after getting a multiple of EBITDA for their Company, they still expect to also walk away with their entire balance sheet.

Final Thoughts

Working capital isn’t an optional add-on in an M&A deal, it’s the operational lifeblood that ensures a seamless transition for the buyer and sustains the business post-transaction.

By understanding and planning for this upfront, you avoid unnecessary friction and position yourself as a prepared and credible seller, ultimately maximizing the value of your exit.

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Thank you!

David