Working capital! I would hate to think how many times that a business I have been marketing has created issues for the parties, with its working capital requirements during the transaction.

Most business owners feel that it is just a cost of doing business and conversely most purchasers, and the financiers, think that WC needs to be added to the ‘list price’ to get the true asking price.

To put it in the most simplistic terms the majority of SME sale transactions are completed as Asset sales. So a new owner will purchase the assets of the business and that would include, Fixed assets of Stock and Plant & Equipment and intangible assets, as the name suggests everything else that makes up the business that is not on a stock or asset list and would include goodwill.

So at settlement the exiting owner would organise to have his/her debtors (outstanding invoices) collected and pay the creditors due as at settlement. A new owner would then be expected to inject the working capital requirements of his new business and in normal circumstances that would be 2-3 months’ rent, wages, opex and normal stock orders if required. This can be a significant amount of money and often will be tied to the business until the new owner exits, and this is the reason that it can adversely affect any transaction.

So it is beneficial for both parties to try and minimise the actual working capital requirements of any target business. Areas to look out for include:

1. Aged Debtor report. A businesses ability to collect their debtors in a timely fashion, hopefully inside 30 days, improves Cashflow and also greatly reduces the working capital requirements. If a business can only collect debtors 60 days and over means the owner has to make up that shortfall thereby increasing working capital.
2. Stock report. If a business has an efficient stock management system then simplistically they should be able to increase stock turns and hold less stock on hand at any given time. Again the more stock you have on hand the more working capital in required to fund it.
3. Supplier terms and conditions. In a lot of cases in NZ businesses existing owners operate with very little debt. So the payment terms negotiated with suppliers often reflect this and stock is often paid on Letter of credit, FOB or on receipt of Bill of Lading. In the case of products coming from China this means that those goods are paid for up to a month before they are available for sale. For a new owner of the same business, who has in most cases borrowed to complete the purchase, this can impose huge working capital requirements to deliver products under the same terms and conditions to the customers, especially if compounded by a lax debtor book and inefficient stock management system. If you are thinking of selling then try to negotiate more friendly payment terms that can be assigned to a new owner.
4. Progress payments. If the business is a manufacturing or projects based business ensure that your terms of payment include progress payments. Again this greatly reduces the working capital requirements.
5. Site Lease. If you think it is possible that you might sell the business somewhere within the next renewal of the site lease then make sure that the size of the site will continue to suit the business going forward. If it is a longer term lease like a 6 + 6 then try to renew for 2+2+2 so that will give a new owner the flexibility to adjust as required. Paying rent for unused space is a mind numbing use of your working capital.

I hope this helps you if you are an owner looking to possibly sell or the buyer looking to buy or even if you are not looking to sell having the opportunity to pull some of your businesses working capital away from the business has to be desireable.