Working Capital and Cash on Balance Sheet

July 30, 2024

by a searcher from University of Massachusetts at Lowell in Worcester County, MA, USA

General question.

On an LOI I'm working on, I've asked for working capital to be included as part of the Enterprise Value. My plan is to supplement this with a line of credit initially to support operations and any delays associated with the transition of working capital post close.

I'm wondering if its overkill to build in some level of cash on my balance sheet as well. If so how much if I already have a line of credit and Working capital built into my deal?

Adding cash to my balance sheet will increase my debt service post close, and impact my DSCR. I'm worried if I'm already in the low end of the DSCR limit of 1.35, I might have to offer less for the business after adding that cash to the balance sheet making my offer less competitive. On the flip side the overcapitalizing the business I think will help me sleep at night.

Am I over analyzing it?

Reply by a lender
in United States

You are not over-analyzing working capital ^redacted‌. For small business acquisition asset purchases, a prudent lender underwriter will always assess the working capital needs for the new owner, covering at least 3-6 months post-loan-closing. This ensures you can meet short-term operating expenses. Depending on the loan size and historical debt service coverage, the working capital financed in the loan might lower the DSCR below the lender’s credit policy, potentially requiring a price reduction. Sellers often overlook that buyers need working capital to cover initial bills unless it’s a stock purchase with an agreed balance of cash at closing.

Remember, not all lenders are created equal. Some require buyers to use their own cash reserves for working capital, while others will finance 3-6 months of working capital in the loan. Some even offer an SBA Express line of credit on top of the 3-6 months baked in your loan for working capital, provided the debt service coverage meets guidelines.

I’ve seen deals where insufficient working capital left new owners struggling to balance loan payments and short-term bills. In such cases, underwriters may modify the loan, adding more working capital if the debt service coverage allows. Depending on the loan size and approved working capital pool of funds, banks will scrutinize where every dollar of working capital is spent, often requiring proof of payment for bills to release the cash. For smaller deals, the lender may release all the working capital cash at closing. There is much to understand and analyze, and then find the bank that will suit your needs. Thank you ^redacted‌ for the heads up and share.

Reply by an investor
from University of Pennsylvania in Charlotte, NC, USA

Could you clarify so that we can offer appropriate advice? You "already have a line of credit and Working capital built into" your deal? That may or may not suffice. Have you discussed the line of credit with lenders? How much cushion does it provide? Is it drawable immediately? How are you calculating the stated 1.35 DSCR and again have you discussed that with lenders? See comments by ^redacted‌ and ^redacted‌ above.

If your LOI includes a good definition of NWC (pegged) and a normal at-closing purchase price adjustment mechanism - I think you indicated NWC will be transferred at close - then theoretically the business will have sufficient WC to operate. A properly structured line of credit supplements that and is intended to cover unforeseen WC needs.

Also not clear what you mean by "adding" cash or "building it in". Are you proposing to borrow it, on top of SBA other other term loan? (Then what is the LOC for?) Contributing it at closing as part of your equity investment? (No direct impact on lender or seller.) Or are you proposing to ask the seller to leave cash in the business? If the latter, and the LOI states that the valuation is on a debt free cash free basis, then asking the seller to leave some cash on the balance sheet does indeed reduce the value of your offer.

Good luck and post back clarifications if you think the SF community can further be helpful.

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