Working Capital: An Important Consideration When Selling A Business
Working Capital is defined simply as Current Assets Less Current Liabilities. Some advisors will include a certain amount of average inventory in Working Capital as well. Some advisors do not include Inventory in the Working Capital. Because of this it is important to define Working Capital as it pertains to each individual deal.
Inventory can be included in the Asking price and can be excluded. A good rule of thumb is for deals over $1 million, a normal amount of inventory is included in the Asking price and not included for smaller deals. Excess inventory (inventory that is escalated due to the seasonality of the business) is usually not included, even for transactions over $1 million. For this reason, it is important to pin down a good average inventory number in the LOI phase of the deal.
Working Capital Target. This is the amount of Working Capital that is required to be sold with the business. Working Capital is a moving target, so it is helpful to set a benchmark amount for closing and adjust the Selling Price up or down accordingly. It is very important to set expectations for this amount at the LOI phase of a deal because expectations about this can differ and cause a deal to unwind unnecessarily.
Working Capital is generally not considered in deals smaller than $1 million in deal size, but it is an important part of deals over $1 million. Working Capital is an important element of a business sales transaction and should be a consideration of every deal. Even small deals will require the Buyer to consider how much Working Capital she or he will need after closing.