Working capital can be a sticking point in negotiations for a small business acquisition.

For today's SMB post, here are the top 5 things you need to know about the role of working capital and how to avoid key pitfalls while buying a business:

1) Working capital is the difference between a company’s current assets and its current liabilities. It impacts a company's ability to sustain operations, invest in short term capital needs, and grow. A healthy operating capital ratio is generally between 1.2 and 2.0.

2) It can be a confusing part of a small business negotiation - for buyers, sufficient WC is needed to ensure the business can operate. For sellers, the need to provide WC may seem counterintuitive ("why do I need fund WC for operations? That's the buyer's responsibility now")

3) Understand how different components, such as receivables, payables, and inventory, factor into the deal. Distinguishing between short-term working capital needs and long-term requirements is key. Sellers are unlikely to agree to fund longer-term capital requirements.

4) There are a few ways to calculate needed WC:

    - Historical assessment: based on past patterns and needs
    - Forecasting: based on a future forecast of potential needs/issues

In a disagreement, deal participants can use lines of credit instead of including WC in the deal

5) A few key tips to ensure proper WC management as you negotiate an #smb deal:

  • - Define clear targets

    - Understand potential WC adjustments based on performance

  • - Be prepared for shortfalls, especially during a transition
  • - Seek expert guidance
  • - Talk about WC early

To see more about this topic, check out our recent article about it: