The Business Acquisition Working Capital.

When one chooses to acquire a business, the discussion will tend to focus on the large numbers - the acquisition price, the revenue, the multiple of the EBITDA. However, as experienced dealers will explain, working capital is one of the clearest signs of a business's true health, yet most people tend to ignore it until it is too late.

The discussion of the contribution of capital in business acquisitions is not merely an accounting process. It is the difference between walking into a successful operation on day one and having a cash flow disaster on your hands, the crisis of which you never expected to inherit.

What is working capital?

Essentially, working capital will be the difference between the assets and liabilities of a business at a certain time. Imagine that it is the monetary buffer that is holding the lights on - literally. It includes payroll, supplier invoices, stocking up of inventory, and all the day-to-day operational expenses that would not stop simply because the ownership has been transferred.

However, this is what renders capital in the acquisitions of businesses a sensitive subject matter: the amount in the balance sheet is not necessarily the only story. Two companies that have the same amount of working capital may have completely different operating realities, based on industries, payment cycles, and seasonal patterns.

Why Buyers Get Blindsided

The majority of buyers enter into an acquisition with an income statement orientation. They desire to observe good revenues, good margins, and steady growth. Naturally, that is quite understandable. However, the hidden risks in the balance sheet are likely to reside in the working capital.

Suppose you have purchased an existing manufacturing business, and two months later, you find that the former owner has extended payments to suppliers to clean up the books before the sale. Or that customer receivables are aged. You find that your working capital, which you thought could see you through the transition, is even less than you had imagined.

This is the reason why capital becomes essential in business acquisitions beyond the amount of cash available in the business. It is about knowing the quality of such capital, the timing of cash flows, and the ability of the business to survive the change in ownership.

The Working Capital Peg: An Idea Every Purchaser Must Be Aware of.

The so-called working capital peg is one of the most significant negotiations during any acquisition; it is an agreed middle ground of the amount of working capital that a seller should provide at the closing date. This cost is usually computed as a trailing average of the working capital of the business over a specified time, which may be 12 months.

The peg should be important since businesses are living, breathing things. Their working capital is always changing. A seller may embezzle cash and receivables until near the time of sale, with no clear goal, depriving the buyer. That is defended by the working capital peg.

This is one of the most vital points of capital in business acquisitions. Too small, and the buyer is not initially financed. Excessive, the seller is made to feel as though he is the one who is squeezed. A deal may or may not stand on the negotiation of this one number.

Additional attention is needed for seasonal businesses.

When you are purchasing a business whose highs and lows occur on a seasonal basis, e.g., a retailer, a landscaping business, or a resort, working capital analysis is even greater. When the acquisition is done is of paramount importance.

The purchase of a ski resort in July may indicate the artificial low working capital since the peak season is yet to come. On the other hand, the acquisition of a vacation retailing brand in December may indicate a cash balance that dissolves in February. In business acquisition, one must consider various points within the business cycle rather than the business at the time of acquisition.

Working Capital is the Starting Point of Integration Planning.

This is one thing that most first-time acquirers do not take into consideration: the post-acquisition integration process is usually the most cash-intensive aspect of the entire ownership process. Systems require refreshing, some major employees might require retention bonuses, supplier contracts might require renegotiation, and customers might withhold payments during the uncertainty of a transition.

The experienced buyers act upon this by making sure that they possess sufficient working capital on closing, not merely, but with a buffer on top of the peg. Any intelligent capital in any business acquisition planning will always have a liquidity reserve that is normally 10 to 20 percent more than the agreed-upon working capital requirement to absorb such first-year surprises.

The Human Side of The Equation.

There is far more of a human aspect to working capital in acquisitions than the spreadsheets. Employees are watching. Suppliers are watching. Customers are watching. A company that has difficulties in its cash flow immediately after the sale is a message - and that message will hurt relationships that years have been working on.

Having a good working capital is not just a question of financial stability. It's about confidence. It will make known to all the players within the ecosystem that the new owner has his act together, that the business is in good hands, and that all is business as usual.

Final Thoughts

Current assets are prosaic. It does not create headlines as a big acquisition price can. However, it is the engine that drives a business out of the storm of changing ownership.

Any individual who is serious about acquisitions must not ignore the importance of capital in business acquisition, not as a technicality to pass through the due diligence, but as a pillar of the whole deal. Get it right, and you are laying the groundwork for a very smooth transition. Any wrong move and even a great business can make one pay a lesson.