Should the seller finance working capital?

searcher profile

December 28, 2020

by a searcher from Massachusetts Institute of Technology - MIT Sloan School of Management in Los Angeles, CA, USA

Seller is pushing back on not providing WC at the time of close. Wanted to get the community's thoughts on how this should be considered? If seller is not providing WC, should the bank provide it or just needs to be more equity infused at the time of close?

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commentor profile
Reply by an intermediary
from Pepperdine University in Los Angeles, CA, USA
As said - at the end of the day it is a negotiation. Typically there is some level of normal working capital left in sold businesses. Most professionals involved in M&A understand this and why it is needed. However with many business owners this may be the first and only business they ever sell and are unaware of the norms/needs. Perhaps they are not working with knowledgeable advisors (or any advisors), which always has pros/cons. Is there a transaction attorney involved at this point - perhaps they could talk some sense into their client?

A couple times in my career I've had sellers just insist that they take the WC and my reasoning on why it should stay in the business fell on very deaf ears (despite repeated attempts) - neither seller were working with advisors overly familiar with M&A.

At that point you need to look at the required WC as part of the purchase prices and fund it yourself. It could throw off the deal if it is large enough. But perhaps it is still a deal you want to do. I'd try to reduce purchase price to offset (at least a portion). If you plan on sucking it up, be very clear with the seller the abnormal concession you are making and hopefully get some credit for other negotiated points,

But yes this sucks and why sometimes having a seller with a good M&A advisor or transactional attorney helps more than it hurts.
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Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA
This is the classic -- it depends. It depends on the basis of the price and how it was constructed (base price, base + inventory, base + inventory + Working Capital), which is largely dependent on the size of the transaction and the database used to come up with valuation (see a post and responses: https://www.searchfunder.com/post/why-working-capital-matters-in-your-search-fund-acquisition).

.It also depends on the deal size. The M&A Source/IBBA Market Pulse four quarter average as of 3Q20 reports that just 21% of deals below $2 million in purchase price included Working Capital, while 79% did not. In the $2 - $5 million range 44% included Working Capital, 56% did not. In the $5 - $50 million range, it shifts to 69% including working capital and 31% excluding it. In any size transaction, cash is usually not included in the price nor transferred to the buyer (even in a stock deal). For those transactions where Working Capital is not included in the price (or acquired explicitly, the lender usually provides a working capital loan in conjunction with the acquisition loan (i.e., you either borrow the WC as part of the acquisition price, or you borrow it explicitly as a working capital loan).
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