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: https://privatemarketlabs.com/the-role-of-working-capital-in-successful-small-business-acquisitions/