Implications of seller intention to take earnings up to close

June 05, 2024

by a searcher from Texas Tech University in Austin, TX, USA

I am working on a deal and I am learning that one of the seller's request is "I plan to take any earnings up to the close meaning if it is billed prior to the close those receivables will come back to me not the Buyer." This an IT services company.

I would like to hear some thoughts on the implications of accepting this clause as a buyer.

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Reply by an intermediary
from Northeastern University in Minneapolis, MN, USA

It's difficult to give you a definitive answer without all of the details on the deal, how it is structured and what closing mechanisms are in place (e.g., NWC as mentioned above). However, what I can tell you is that deferred revenue is often viewed as indebtedness / a reduction of purchase price. Assuming that we are way past the point where you can propose this given his stance, it would be reasonable to ask him to leave in the estimated cost to serve associated with the billed revenue he ultimately collects AND for any deferred revenue he's collected in cash already. This way you are giving up the margin associated with these billings, but he isn't leaving you in a hole you have to climb out of. Just make sure that the agreement states that customers are billed consistent with past practices to cover you in the instance he tries to bill for multiple periods, when in the past he was only billing on a monthly basis. At the end of the day, it's all negotiable and you should look at the economics of the deal as a whole to assess if it makes sense for your situation.

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

^redacted‌ answer addresses many good points. 1) Sellers are entitled to all profits till the date of closing. 2) In seller is billing at the beginning of the month, then technically revenue, should not be recognized until services are provided, However, often sellers recognize this as revenue with no expense. If the same practice occurred in the prior month, then current month's expenses will reflect revenue recognized in prior month. If the A/R is captured in NWC properly, you will be ok. You have to be careful that Seller does not accelerate billing. You should also make sure that you do not have too many first-time customers the day before the closing b/c that will increase AR beyond the NWC peg and hence you will wind up paying the seller and incur the cost to service that new AR. 3) Happy to talk. Once I sold a business (an ISP) with pre-billing monthly, quarterly, six months and annual. It was nightmare to convince both sides for a fair way to determine peg and closing adjustment.

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