One big hurdle I continually run into is brokers and / or sellers that don't understand working capital, primarily the fact that the valuation on the business assumes ongoing working capital in the business. Most sellers I've been communicating with think that they should be able to take all of the AR (and assume the AP) since "they did the work". Which, I'd be okay with in exchange for a commensurate reduction in company valuation, since I'd have to fund the new working capital with additional cash. But, they want the 4-5x EBITDA valuation plus take the working capital, which can be the equivalent of 1-2x EBITDA in some cases.
Part of the problem is that there are many brokers who don't understand this point either, and advertise the deals as "cash-free, debt-free, and receivables-free".
Any tips or ideas on how to get people to understand this point?
How to get brokers / sellers to understand working capital?
by a searcher from Massachusetts Institute of Technology - MIT Sloan School of Management
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Post covid, we've seen two approaches to the NWC calculation. Both are cash free/debt free. One is the traditional average cash free/debt free NWC over the trailing 12 months to adjust out any seasonality or unique material events. The other is to look at what the business was doing in 2019 on a pre-covid basis. We've seen a number of buyers try to price a deal based on the pre-covid financial performance of the business as well as to calculate NWC. In most cases, there is no magic answer. The end result often lies in some negotiated compromise.
There is one other factor to consider. If the business traditionally has a fair amount of receivables that age over let's say 60 days, but the owners pay their bills in net 30 or less (we've had one seller who paid his bills immediately on receipt), there will be an imbalance in NWC and that may need to be a negotiated adjustment to average NWC. Lastly, the simple example to site for sellers who think they should take all of the receivables is this: If you buy a car, the dealer doesn't tell you to push your new car down the road to the gas station because there's no gas in it. The same scenario applies to an appropriate level of receivables to continue to operate the business. The receivables are the gas in the tank. Hope that is helpful for you.