by Tony Carter
When valuing a business for sale or purchase, owners often believe that the value will be based on a cash-free debt-free multiple of earnings.
While this is technically correct from a valuation point of view, the commercial reality of working capital requirements is often overlooked and is the cause of disputes.
Working capital is a measure of the business’s liquidity and is made up of current assets (e.g. debtors and stock) less current liabilities (e.g. trade creditors, GST, PAYGW, superannuation). Put simply, it is the funds required to carry on the day-to-day operations of the business.
Negotiating Working Capital in a Business Sale
While any business owner will tell you that a cash buffer or an overdraft is required to manage the ups and downs of cash flow, when it comes time to transact on the business the vendor and purchaser will likely have differing opinions on what is to be included in working capital:
- Vendor: They will want to exit the business with all the cash and possibly even the debtors, and are not a part of the business being sold
- Purchaser: They will argue that the purchase price should get them everything they need to carry on the business from day one, and they should not need to inject further funds to keep the business operating.
There is no hard and fast rule on which position is correct, rather it is a matter of negotiation between the vendor and purchaser on how working capital will be treated in a transaction. To avoid a nasty surprise on the settlement date, this should be negotiated as early as possible and clearly recorded in the purchase and sale agreement.
This is often not a simple process as working capital levels at the date of the latest financial statements can be different during the due diligence period and through to the settlement date. Working capital levels move around due to:
- Timing of sales receipts
- Timing of expense payments
- Seasonal build-up of inventory
- Lumpy or irregular payments of taxes
How We Can Help
Whether you are looking at a business to buy or thinking about selling yours, we can advise what working capital adjustments you should be negotiating for inclusion in the contract. We will talk you through the issues and ensure you get the most “bang for your buck” when buying a business, and don’t leave anything on the table when exiting one.
Just contact Tony Carter in the form below of call (02) 4969 6600.