Hi Pedro, in my experience you should negotiate a WC hurdle. As part of the acquisition you need specific WC to operate the business and deliver the EBITDA target. Here is an article that explains this> https://www.financierworldwide.com/protecting-deal-value-working-capital-hurdles-in-ma-transactions#.YD0ZOehKiUk
Best,
Ricardo

Agree with Ricardo. If you give him the AR, its like a car without a steering wheel. However, you could do it as part of the overall deal - I would not look at it in isolation. Finally, if you do let him retain AR, I would recommend he retain AP. In this scenario, make sure you retain the right to collect from customers....and maybe even take a 5-10% collection fee. you only pay him when you get paid.

Presumably, the seller has has no prior experience with selling a company. The term Working Capital is foreign to many first time sellers. I prefer to lead with some open ended questions with the intention of indirectly educating the seller about working capital without necessarily using the term. One question could be "Do you think that the seller should have to put more money into the company above and beyond the purchase price in order to a make payroll, pay AP, buy inventory etc. after closing? If he/she says yes, then follow up with "Isn't that the same as a s higher price that we already negotiated? "How do you propose that we get around this? If he/she says NO, then ask him/her how he would propose to ensure that these is sufficient cash, AR, inventory less AP to accomplish this.

Tagging ^[redacted]‌ who I know has deep expertise on complex working capital situations

I have nothing to add here other than to say this is a great question and one we just ran into. A commercial cleaning company we were going to acquire wanted to keep AR. This was going to lead to the need for $80k in additional working capital or 18% more expense. We declined to move forward because of this.

Two good discussions threads on the topic:
https://www.searchfunder.com/post/why-working-capital-matters-in-your-search-fund-acquisition

https://www.searchfunder.com/post/how-to-get-brokers-sellers-to-understand-working-capital

The answer largely is -- it depends. It depends on the size of the transaction and the database that was used to come up with the multiples (SDE or EBITDA) as part of the valuation.

While there is no question that a buyer needs working capital on day 1, it turns out that only a minority of transactions in the <$5 million size include working capital in the purchase. The IBBA/M&A Source posts quarterly data that show the % of transactions that include working capital vs. exclude it. In summary, looking at the average for the last four quarters for deal sizes in the $500k-$1M range only 21% included working capital, $1-$2M only 24%, $2-$5M only 42%, but in the $5-$50M 71% included working capital.. In the cases where it is not part of the purchase, it is usually provided by the acquisition lender in the form of a permanent working capital loan and possibly also a line of credit (this is usually right on their term sheet next to the acquisition loan).

It's important for buyers and sellers to know what perspective along the working capital continuum the company was valued and then offered at. That continuum being: (1) base company value + (2) other assets/liabilities (such as deferred revenues, customer deposits, payroll/vacation/bonus accruals, etc.) + (3) inventory + (4) AR/AP + (5) other = (6) aggregate company value.

Most transactions that buyers see on sites like BizBuySell or Axial are going to be a combination of 1+2+3, and exclude 4+5. In these transactions the buyer does not pay for the net value of AR/AP, instead, the seller keeps them and the buyer takes out a working capital loan along with the acquisition loan to cover future working capital (this is how many SBA loans are structured). Occasionally, the buyer will want the AR/AP for customer experience reasons, and will buy the net AR/AP dollar for dollar or close thereto.

The key is to make sure that when using a valuation multiple to come up with the asking/offer price that the comparables used are in sync with assets/liabilities being offered/requested. Each database handles the working capital differently, so the user has to know the inventory and net working capital rules before applying them to a transaction -- just like it would be a significant mistake to apply a multiple of SDE to EBITDA, it would be a significant mistake to use a multiple that excluded working capital and then use value derived from that multiple to represent a price that included it.

In short, here is how each of the major comps databases handles inventory and working capital:
-BizComps: specifically excludes inventory and AR/AP (you are getting values 1+2 (if entered)).
-PeerComps: includes normal inventory, excludes AR/AP and other working capital. You are getting value 1+2+3.
-DealStats (fka Pratt's Stats): Can include or exclude net working capital - this varies greatly by industry and data set pulled. The user must look at the asset allocation detail for the comps being used in order to determine where on the working capital continuum those particular comps are located and thus appropriately sync the derived value to the appropriate level of net working capital included.

As per a couple previous answers, if you're buying a business you should get the WC needed to operate day one. If you're buying an opportunity... You need to get the needed amount of net WC included in the deal.

It seems there are two issues. A) Seller wants to retain AR, and B) What should be peg? I will discuss A).
Seller wants to retain AR: Buyer is better off buying AR and seller is better off buyer collecting AR. There are many reasons for this. AR should be included in P. If it is not, it is an economic decision for the buyer. Sellers often insist exclusion, often due to ignorance but also due to advise from brokers or CPA/attorney. Brokers do that due to lack of sophistication, CPA./Attorney do that to see if they can hell seller extract more from buyer.. There is no easy strategy to convince the seller w/o knowing more details of total working capital (AR, Inventory, AP, accrued, deposits, accounting and costing method, bad debt history, etc.). Happy to help. Just reach out. FYI, I teach this subject.

I agree with Mike, it's usually ignorance. It also depends on the amount of WC. I'm working on a deal where the net WC is about zero because most sales are on a credit card at the time of sale so it's not an issue. But if most sales were billed we'd have well over $500K of WC and it would be an issue. It's a gut decision if the seller won't change their thought and you've given the options, walk away or pay more. Tough call. And, the size of the deal matters. The smaller the deal the more the seller looks at every dollar.

Hi Pedro, I am running often into this discussion. Most of the time it helps to explain that you are acquiring and evaluating the company on a going-concern basis and hence including all operational assets as well as liabilities, such as Accounts Payables as well as Accounts Receivables. In my experience this normally helps kicking-off the discussion as the seller is now in a position where he would need to explain why he includes only AR and not also AP.

Please let me know, if you have any further questions on this one.

Good approach