How do you cover payroll 1 month following acquisition?
August 14, 2024
by a searcher from Morehouse College in Washington, DC, USA
I had a deal fall through last year because I didn't have enough working capital and the bank wasn't willing to lend the entire amount that I needed. In summary it was a professional services firm with nearly $4M in annual revenue. Monthly payroll was about $200K and accounts receivables were collected on net 60 terms. The firm was a government contractor so the income was guaranteed but the challenge was covering the $400K needed for those 60 days while also covering my equity injection. Plus I wanted additional wiggle room for any unexpected incidentals and debt coverage. Basically $600k working capital would have been a sweet spot. Someone else came and offered the full asking price with no concessions or accounts receivables included in the purchase. The seller liked me more but didn't want to turn down an offer for exactly what they wanted (which i completely understand and would have done as well) ... had I been able to match I would have gotten the deal.
So now my question is ...
How would you have salvaged this deal? What buying strategy, negotiating tactic, or lender / investor would you have leveraged to get the deal done?
from University of Cape Town in New Zealand
In theory, the transaction should be structured such that the purchaser should not be injecting any capital on day one. The working capital should be part of the purchase price ( Enterprise value + actual working capital – less Target Working Capital = Equity Value (paid)). Sometimes, you have to work backwards from a vendor's expected equity price (paid). What it means is that the enterprise value (business value) is adjusted.
And if the derived enterprise valuation is not in line with the value thesis, then maybe it's time to walk away. In your case the other buyer ended up with a valuation of the business higher than you offered.
A key issue is liquidity requirement (which is not working capital) for example wages could be due 2 days after close. Typically, the buyer negotiates that the business retain the bank accounts including overdraft facilities. Alternatively negotiate to have the the payroll bank accounts funded at close.
The negotiated items (working capital) should not prejudice Seller but rather facilitate a smooth transition. Most Sellers miss this point.
Lastly having a Seller retain the accounts receivables (and payables) and manage collections (and payments) could be commercially risky.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
Just because someone else is wiling to pay more or do the deal without working capital, it does not mean it is a good deal for them. They could be over-paying. Or they may be a strategic or a larger firm either putting more money down or with the cash to cover the working capital.
The other issue that could have existed is that not all lenders are alike. Some do not like to provide much working capital. So it could have been a lender issue as well, but again hard to know without looking at the free cash flow.
If you ever have questions or need another set of eyes to look at something from a lending perspective, we would be happy to assist you. We do not charge anything to review a deal for a client and work purely on a Success Fee basis on the financing side. You can reach me here or directly at redacted