Hi Reader

Did you know there's a number more important than "SDE" when it comes to buying a business?

That number is "NWC" or Net Working Capital, and whether you don't know what the number is, or you know it but ignore it when structuring your deal, the outcome is the same:

You'll run out of money.

We're not just talking about running out of money figuratively, but literally.

It means you might close on your deal, and technically own a multi-million dollar business, but 30 days in, when you are on the hook for:

• Rent

• Payroll

• Vendor payments

• Payments on your $3M PG'd SBA loan

Your company bank account will fall well short and you'll need to personally put more money into the business.

Not good.

Ready to learn how to avoid this nightmarish scenario?

Great! That's what the rest of this issue is about.

What is NWC and How To Calculate

This is one of the questions I get asked most often. It's also one of the hardest concepts to understand; by Buyer AND Sellers.

So, I decided to ask Chris Barrett, founder of Midwest CPA, to help me with the explanation.

Chris is one of the top Quality of Earnings providers in the ETA world and he's also one of the best at explaining and analyzing NWC on my deals (especially pre-LOI when it really matters).

Here's what Chris has to say:

What is Net Working Capital?

Net Working Capital (NWC) is the difference between a company’s current assets and current liabilities. In simple terms, it is the short-term liquidity a business needs to keep its operations moving. Accounts receivable, inventory, and accounts payable are the main components.

Why is NWC Important?

NWC tells you whether a business can cover its day-to-day obligations. For buyers, it signals how much cash is tied up in the business after closing. Too little working capital can create immediate financial strain and results in an essential increase to purchase price by requiring additional cash at closing. It also may represent opportunity as businesses with a bloated cash conversion cycle may suggest inefficiency or an opportunity to free up cash.

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Which Businesses Need It Most?

• High NWC Needs: Product-based companies that carry inventory and wait to collect receivables. Examples include distributors, manufacturers, and contractors. These businesses must fund payroll, raw materials, and overhead while waiting for customer payments.
• Lower NWC Needs: Service-based firms with upfront billing or subscription models. Examples include software companies or professional services firms. Since these businesses often collect cash before or at the time of service, their operations are less dependent on working capital.

How to Estimate NWC Pre-LOI

Before signing a Letter of Intent, buyers should build a rough estimate of NWC needs. A practical method is to use the cash conversion cycle (CCC):

1. Calculate Average Daily Sales: Divide annual revenue by 365.
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2. Estimate the CCC: Add Days Inventory Outstanding and Days Sales Outstanding, then subtract Days Payable Outstanding.
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3. Multiply: Average daily sales × CCC = estimated working capital requirement.

This calculation provides a ballpark figure to guide deal discussions. It is not perfect, but it helps avoid surprises and gives buyers confidence when negotiating a working capital peg in the LOI.

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​Real world example:

One of our clients was acquiring an electrical contracting business and asked us to review the financials. A key issue was the seller’s proposed net working capital transfer, which was set well below what the business truly needed to operate. The seller’s calculation suggested less than six figures would be required after the transaction, which raised an immediate red flag.

Through our quality of earnings analysis, we determined that the business actually required over seven figures in working capital. We showed how the long cash conversion cycle drove that need and outlined the flaws in the seller’s assumptions. After several rounds of discussion with the seller and their counsel, our analysis was accepted.

The result was an adjustment worth more than a million dollars in value to our client. Months after closing, they told us they felt in a strong cash position and credited the negotiation around working capital as a key reason why.

Where will NWC Come From?

Once you understand the NWC needs of your target business, it's time to decide where that will come from.

And there are only four sources:

1. The Seller leaves a normalized amount in the business at closing (ideal). Translated: they give you a normalized level of inventory and accounts receivables
2. Your SBA lender builds it into your loan proceeds
3. You secure a line of credit (LOC)
4. You fund it personally from your own cash

Of course, if you don't do a good enough job of ensuring that you have NWC funded from a combination of the first three sources, the default source will be your own cash, and unless that's something you've planned for, it can be a financially draining disaster.

Pro tip: ALWAYS get a LOC, even if you think you’ve fully funded your working capital needs.

Post-close is the worst time to apply. Most LOCs require a first-position lien on AR, and you won't get it once your SBA loan is already in place.

Typical Deal Structures (by Deal Size)

Who funds NWC by deal size?

After providing buy-side advice on close to 200 deals, here's what I've seen as typical:

< $2M: Expect to personally fund post-close NWC (from your lender or your personal cash). Though you should ensure seller leaves a normalized level of inventory (if the business uses it) and you negotiate a commensurate discount to the purchase price.

$2M-3M: Mixed bag. Sometimes sellers leave working capital in, other times not. You have more leverage here.

$3M+ Working capital peg is usually negotiated pre-LOI and formalized in the APA. Expect to set the "peg" or "target" based on the 12-month trailing average.

The bigger the deal, the more this gets negotiated. But even in smaller deals, smart buyers know to model NWC and confirm the plan early.

How to Structure NWC into Your Deal

Pre-LOI

• Use CCC method to estimate rough NWC needs (do not leave this open ended - mis-alignment on NWC expectations can wreck deals, and the more you're into the deal when this happens the more it costs you)
• Ask seller what they’re planning to leave in the business
• Push for a reasonable peg if you're in the $2M+ range

During Diligence

• Get a QoE analysis (especially for inventory/AR-heavy businesses)
• Look for manipulation: delaying AP, pushing AR, stocking up on inventory pre-close
• Confirm trailing 12-month average NWC and seasonality

In the Purchase Agreement

• Define what counts as NWC (usually AR+inventory minus any AP)
• Lock in the agreed peg and how it’s calculated
• Spell out the post-close true-up and adjustment mechanisms

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​Pro-Tip: Don't rely on your lender to model out NWC for you. While they usually do a reasonably good job, especially for larger or more complicated businesses, you absolutely need a financial diligence pro like Chris to do the detailed analysis and modeling.

Also, never, ever rely on the seller or (even worse) the seller's broker for an estimate of NWC needs. Not only are they usually way off base even with a good-faith estimate, but they have a vested interest to under-estimate and, as Chris points out in his example, they can be wildly off in their under-estimation (and you'll be left holding the bag).

Final Word

Most buyers don’t think about working capital until they feel the pinch post-close.

Now you know better.

Ask early. Model it. Structure it.

If you do, you won’t just buy the business—you’ll own it with confidence.

Stay sharp

Eric

Buyers Black Book