Understanding Working Capital in a Successful Business Acquisition or Where is the Working Capital?

Understanding Working Capital in a Successful Business Acquisition or Where is the Working Capital?

Working capital definition- 1. The amount of capital needed to carry on a business. 2. Accounting- current assets minus current liabilities. 3. liquid capital assets as distinguished from fixed capital assets.

Types of Working Capital Needs Permanent capital- Permanent capital remains working in the business. It is generally funded by equity injected into the business or the paydown of term debt. Every business needs some permanent capital.

Revolving Lines of Credit- Lines of Credit are funds which are revolving and can be repaid and reused. Most banks require a paydown to zero balance for 30 days of the year to show that the funds are not permanent working capital. Lines are provided from banks, SBA guaranteed loans, private companies and individuals. These lines can be Seasonal to deal with Inventory buildup for holiday season for instance, or just for general business cycles.

How do Lines of Credit Work?- a variety of ways depending on the agreement. Borrowing Base- Lender will advance up to a predetermined amount based on percentages of assets and general condition of the company. Unfollowed Line of Credit- Loan given for working capital which is available to a predetermined amount. Reviewed annually by the institution. Followed Line- based on formula through lockbox to the operating account. Monitored consistently and paid consistently depending on the agreement.

No matter how structured, the current asset is the key to repayment and the monitoring of that is a main focus of the lending.

Where do you look for working capital? Where is the balance sheet? Find it in Quick books, Tax returns, financial statements. Asset lists in the purchase. Balance sheet as a snapshot in time. It may not represent the full year depending on the seasonality and highs and lows of the business. Look to the balance sheet as a starting point to determine how a company operates and what metrics to use. For instance, if the company collects AR in 60 days, it is likely your buyer will continue to collect in 60 days.

Where do you look for wc in structuring an acquisition? What changes will occur to the balance sheet when the new buyer takes over? How is the sale structured? Does the seller take the AR and the cash? If inventory is bought in the sale or as a separate item- how will that affect the sale?

The Importance of working Capital in the deal structure If a company does not have enough working capital, it will not be able to sustain operations and thrive. No matter the deal structure, consideration has to be given to the amount of working capital required in the transaction. - Historical operating experience from the Seller is the best indicator of moneys needed. - Accounting calculations are a good method for verifying this such as: COGS/360 X 30 plus operating expenses = month cash requirement. - Determining the speed of collection of the AR in the cash cycle of the business to see how many months are required to collect AR. Eg how many days does it take to collect the AR?

Funding Working Capital through a variety of sources. Can be satisfied by: - Line of credit availability including all sources such as floor planning, factoring, warehousing, - Permanent capital from term debt - Personal liquidity and willingness of ownership

Case Study 1- Manufacturing service company Company provides a service to the aerospace industry, but holds no inventory as product is supplied by customers. Sale is structured as a stock purchase for $1.3M. Bank is financing $1,073,000 with buyer cash injection to complete. Seller keeps AR post closing. What working capital should be built into this transaction? See Handout for financial info.

Results since closing- Case 1 Buyer has expanded the Business- Sales of $2,000K with net profit of $343K after owners salaries of $188K and interest of 25K. Buyer has a small LOC which has not been used.

Case Study 2- Company sells to public and services their product Ten year old company being sold by founders Company was sold in an asset purchase for $750,000 plus $100,000 in inventory. No real estate was included in the sale. What working capital should be built into this sale? See handout for financial information.

Results Borrower received a $750,000 SBA 7(a) Loan to complete the purchase. Working capital of $70,000 was built into the term debt to provide permanent working capital for inventory in the business.

Q & A Anina Butler, SVP Jennifer Mason, VP Radius Bank Radius Bank One Harbor St, Suite 201 One Harbor St., Suite 201 Boston, MA 02210 Boston, MA 02210 617-728-7320 Office 617-303-7468 617-943-4116 Cell 781-771-3919 abutler@radiusbank.com jmason@radiusbank.com

Case 1- Manufacturing company dominantly to aerospace industry. Provides a service and does not hold inventory as inventory is supplied by the customers. Selling for $1.3M in a stock purchase. Bank is financing $1,073,000 with buyer cash injection to complete sale. Price allocation looks like: Real Estate- $600,000 Equipment - $ 50,000 Goodwill etc- $650,000 Borrower has strong manufacturing experience and is personally liquid. Where is the working capital?

Case 2 Company distributes a luxury consumer product to the public. Company is 10 years old and is being sold by founders. Purchase was an asset purchase of $750,000 plus $100,000 of inventory. No real estate was included in the sale. Where is the working capital in this business and what should be built into the deal?