Winter 2008: "Delivering a Company"... Know What the "Price" Includes

If not properly represented or advised, many business owners will accept an offer on their company and proceed through the due diligence process, only to get a huge and usually unwelcome surprise before closing. "What’s included" with the company, and how it is "delivered" at closing of sale and "handing over of the keys" can have a tremendous affect on the overall deal value and "walking away" money to the owner. THEORETICALLY, A COMPANY is delivered to a buyer on a cash-free, debtfree basis with adequate amounts of working capital. At closing, in theory, the owner/seller will receive the purchase price of the company, while all long

Mike Ryan

term debt and lines of credit will be paid directly from the sale proceeds.

The owner/seller will then sweep the checking account and keep all the cash. Hence, "cash-free, debt-free basis". Typically, unless otherwise excluded, the purchase price includes all the furniture, fixtures and equipment: "FF&E".

Easy, right? But, what are "adequate amounts of working capital"; in fact, for these purposes; how do we define working capital? Furthermore, how is working capital different from book value of the company for sale purposes? These issues become complex and are best determined up front and prior to agreeing on overall terms of a deal.

As an owner/seller begins the process of selling their company, it is best to keep focused on what is included in the delivery of the business to the buyer, and what is not included. While there is an overall purchase price for the business, this can be materially different from the actual proceeds the owner/ seller walks away with, the "Net to Owner".

Depending on the nature of the business, manufacturing, service, IT or distribution, the working capital definition may vary slightly, but the affect on the Net to Owner will still have a large impact. Typically, in a transaction, the working capital is defined as accounts receivable ("A/R") plus prepaid expenses plus inventory, minus accounts payable ("A/P") and accrued expenses. Therefore, the transaction usually includes some level of these amounts and values included in the sale price.

Straight forward, right? Sometimes; but what if some substantial portion of the AR is aged and not collectible? What is the value of the inventory? What if there was an unusual and non recurring sale that caused a brief increase in the value of the AR? Should that go to the buyer? The answers to all these is, it depends. However, in all cases these factors will affect the Net to Owner.

Often, an owner will evaluate an offer and look at the "sticker price" while focusing less on what’s included in that "sticker price". Sometimes a buyer will develop their own analysis of adequate amounts of working capital to be included in the delivery of the company, and other times the buyer will simply pick these amounts off the most recent Balance Sheet. How, and more importantly, when should these issues be discussed and resolved?

Earlier is always better; in fact, when an owner/seller is evaluating and negotiating the offer is the key time to ascertain what is included in the delivery of the company. Without professional M&A advice, owners/sellers may proceed through the sale process, spending months of resources, only to get a rude awakening right before closing.

When evaluating offers, owners should:

		Look at the purchase price put forward in the offer.
		Consider treatment of the company’s cash position.
		Define components and amounts of working capital up front.
		Know what the buyer expects in terms of adequate amounts of working capital.
		Ascertain treatment of excesses or shortfalls of working capital at closing.
		Understand treatment of long term debt and lines of credit.

Not withstanding capital gains tax, the aforementioned factors will have a material affect on the amount the owner ultimately receives, which in the end is all that counts.

Since there is no such thing as a theoretically perfect transaction when selling a privately-held business, owners need to give due consideration to what is included in the delivery of the company. Often, given the size and nature of the business, these components may results in a "go or no-go" decision on the part of the owner.