The impact of working capital changes on your business sale proceeds

When selling a business, most management teams and owners focus on headline valuation metrics—multiples of EBITDA, revenue, or cash flow.

But there's a less obvious factor that can have a surprisingly large impact on your net proceeds: working capital.

In an M&A context, working capital affects both what the buyer will pay and what the seller ultimately takes home. Missteps in planning or calculating working capital can lead to unexpected reductions in your proceeds—or even jeopardize the deal because the buyer loses trust in the numbers and walks away.

If you're taking your company through a sale process, here’s what you need to know and how to plan effectively for working capital.

What is working capital and why does it matter?

Working capital represents the short-term assets and liabilities of your business, such as accounts receivable, inventory, and accounts payable. It’s essentially the cash needed to keep the business running day-to-day.

In most deals, the buyer expects to receive the business with a “normal” level of working capital. This ensures the company can operate without requiring an immediate cash infusion.

If working capital falls short of this agreed-upon level, most M&A agreements specify that the buyer may reduce the net payment to the seller to make up the difference. Conversely, if it exceeds expectations, the seller receives a boost in proceeds.

How working capital can impact your sale proceeds

1. Closing adjustments: Most deals include a mechanism to adjust the purchase price based on the actual working capital at closing compared to a pre-agreed “target” level. Misjudging this target can lead to significant, last-minute price adjustments.
2. Buyer negotiations: Buyers often scrutinize working capital trends to evaluate the health of your business. For example, a sudden spike in accounts receivable or a buildup of slow-moving inventory might raise red flags.
3. Board approvals: Sometimes, the deal requires the seller's board approval and late-stage negative adjustments to the purchase price could be perceived by the board as the buyer "re-trading" - and cause the approval process to be delayed.
4. Cash flow expectations: A buyer will assess how efficiently your business converts working capital into cash. Businesses with poor working capital management may see lower valuations due to perceived risk.

Tips for business sellers: plan ahead

1. Understand your working capital needs: Analyze your business's historical working capital trends. Identify seasonal fluctuations, payment terms with customers and suppliers, and any changes in inventory practices. This helps you anticipate what a buyer might consider a “normal” level. Based on the specific business, needing to do a look-back for a full year or even two years is not uncommon.
2. Avoid drastic changes pre-sale: Avoid artificially boosting working capital (e.g., delaying payables or pre-paying expenses) to make the business look healthier. These actions can backfire during due diligence and erode buyer trust. Once the buyer stops trusting your numbers or management's competence in running the business, its hard to recover.
3. Document and justify changes: If there are unusual working capital movements—for example, stocking up on inventory ahead of a seasonal rush—ensure these are well-documented and explainable. Buyers appreciate transparency.
4. Negotiate the working capital target carefully: Work with your advisors to negotiate a fair working capital target. The target is typically based on historical averages, but it’s crucial to ensure it reflects current business conditions and any growth initiatives.
5. Manage receivables and payables effectively Before a sale, focus on collecting overdue receivables and managing supplier terms efficiently. Buyers will closely examine aging reports and payment trends. Cleaner receivables and payables lead to fewer questions and smoother negotiations.
6. Get expert help early: Engage advisors with expertise in M&A and working capital adjustments. They can help you identify risks, negotiate the target level, and ensure closing adjustments don’t erode your proceeds.

Final Thoughts

Working capital is often overlooked in early sale discussions but plays a critical role in determining what you walk away with.

A well-prepared seller understands the nuances of working capital and takes proactive steps to avoid surprises. Make sure working capital adjustments don't unnecessarily derail your transaction or diminish the proceeds.

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