Many small businesses are sold with no cash and no debt, while many larger ones are sold with a reasonable amount of working capital left in the business. You can think of this as buying a car with no gas, vs. buying one with gas in the tank.
Sometimes small businesses (typically those sold using seller’s discretionary earnings, SDE, as the valuation metric) are sold with absolutely nothing in the business, no gas in the car at all. No cash, no payables and no accounts receivables. The new owner needs to recognize that and leave themselves enough cash to be able to fund the working capital needs of the business.
Larger companies (typically those that use EBITDA as the valuation metric), are sold with gas in the car. That is, a new owner buys the company with the expectation that enough working capital (including cash, AR, AP, inventory, etc.) is left in the company to continue to run it.
That doesn’t mean that all cash is always left in the business. Excess cash, which would be the amount of extra cash on hand that isn’t required to run the business, is taken out and “taken home” with the seller. So how is it determined how much working capital is left in the business?
I’ve had buyers use a few different calculations, including a “net asset” calculation and a net working capital calculation (current assets less current liabilities), but the goal is the same. That is, putting a “stake in the sand” during negotiations to determine what level of working capital will be turned over to the buyer at close.
One way is to use a specific point in time along the way, say when the letter of intent is signed. Another way is to use an average of historical working capital amounts over six months or a year.
compasspointcapital
com