Working Capital Negotiation with Small Business Owner

January 09, 2023

by a searcher from University of Virginia-Darden - Darden School of Business in Charlottesville, VA, USA

The working capital portion of the negotiation has always been a hurdle when talking with small business owners because it's typically their first time going through a business sale (and if there is a broker, they're not always helpful###-###-#### The most recent situation has been challenging. At first, the seller wanted to retain the AR balance at close or be paid for it in excess of my offer. After I explained the rationale for it being a part of the business purchase, we negotiate the working capital peg that would be used to measure against at close. Making things a bit more complicated is a recent price increase that is pushing AR up on an LTM basis (I'm conceding on a higher peg because this increase should benefit me on a run rate basis).

All this being said, I'd love to hear how others approach this step in the negotiation. How early do you tackle it, and is there a tried and true way to make it a smooth discussion with an understandably unsophisticated small business owner?

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

I am an M&A Intermediary. I teach WC and have few times have been asked to help fix a broken (due to WC) deal (not represented by me). WC is part of the purchases price, no if and no buts. Recently I was involved with a deal where PWC represented the buyer and seller was represented by a level-2 accounting firm and an I-banker.
On a small main Street deal (which are typically retail) WC is excluded and hence the multiples are lower. On larger deals, Buyer/Seller can choose to exclude WC from the offer but in this case the transaction price reduces.
In all my deals for 35 years, WC is part of the LOI. There are times buyer's push back in LOI to a something like "Offer includes WC required to run the business" and hence PEG is TBD later. I have ways to tackle such situation.
Regarding rising prices, it does impact WC PEG but, in my mind, the materiality is often small and buyer's distraction from DD is high. Sellers, who has finally accepted WC inclusion in price, get more upset with WC impact of rising prices.
Happy to have preliminary discussion. Just DM me.

Reply by a searcher
from Northwestern University in Scottsdale, AZ, USA

First make sure LOI is clear on if NWC is included or not and that you are not comparing apples to orangs. We usually look at the deal based on Enterprise Value to EBITDA ratio, and Enterprise Value by definition does include working capital even if its a "cashfree debt free" EV. As for negotiation, we typically just say we need working capital that will be needed if there was no transaction (i.e. in normal course of business). If the Seller is projecting a growth, or have price increases expected, and you are pricing that in to the Enterprise Value, it is reasonable to expect/require that the working capital target to increase also.

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