Hi Reader

Working Capital: Deal Nemesis and Lifeline

Net Working Capital (NWC), Works in Progress, and Warranties are the "3 Ws" that often derail deals. Mastering these will set you apart, enabling smoother, fairer negotiations and closing deals effectively.

This three-part series starts with NWC—an acronym that strikes fear in even the most experienced buyers.

Often misunderstood by both Buyer and Seller, NWC negotiations have killed more deals that anything else I've seen. Worst yet, underestimating (or completely missing) NWC needs has killed businesses AFTER acquisition, leaving buyers wallowing in debt or headed to bankrupty.

Never fear though: in today's issue, with actionable advice drawn from my experience and insights from deal experts, you’ll be better prepared to tackle it head-on.

NWC: The Engine’s Fuel

NWC is the current assets a business holds (cash, receivables, inventory) minus current liabilities (payables, deliverables). It’s the fuel that powers daily operations, paying for payroll, rent, and vendor invoices. Without it, the business—and your acquisition—grinds to a halt.

Failing to secure adequate NWC can be disastrous, especially with loan payments looming post-acquisition. To operate successfully, you’ll need NWC from one of three sources (listed in order of preference):

1. Seller: Ideally, the seller leaves sufficient NWC in the business as part of the deal. This isn't always straightforward, especially with smaller or less experienced sellers.
2. Bank: Banks can provide NWC as part of your acquisition loan or as a line of credit (LOC). Pro tip: even you get NWC elsewhere, always get an LOC for flexibility—surprises happen post-closing.
3. You: If other options fall short, be prepared to inject personal funds to keep operations afloat.

A Seller’s Dilemma

For sellers, leaving NWC can be confusing—especially in smaller deals with retiring baby boomers or without experienced advisors. Explaining why this is essential often feels like asking them to "sell their business and give you money back."

This confusion is why I recommend addressing NWC in your LOI. Waiting too long risks wasting time and money on a deal that ultimately collapses.

Structuring NWC

Here’s how to navigate NWC in different deal sizes:

Pro tip: include as much detail about your proposed NWC model as you can at LOI stage (including estimated numbers subject to diligence). Leaving NWC completely open for discussion post-LOI can result in a deal dying late in the stage after you've invested significant time and money.

1. Deals <$2M EV:
   • Estimate NWC needs and deduct from the purchase price.
   • Seller keeps accounts receivable (A/R).
   • Maintain normalized inventory levels.
   • Fund NWC via your acquisition loan or LOC.
2. Deals >$2M or with experienced sellers:
   • Complicated business models or WC intensive businesses (like large construction or manufacturing):
     • Set an NWC “Peg” (e.g., $800K) based on diligence.
     • Seller leaves the Peg amount at closing.
     • Implement a 90-day true-up and escrow to address discrepancies.
   • Straightforward business models (asset light, low overhead):
     • Agree on an NWC Peg without true-up or escrow
     • Shortfalls at Closing adjust purchase price or are covered by seller cash.

In both cases, insist on accurate bookkeeping and a mechanism to recover shortfalls post-closing, such as offsets against the seller note or a NWC escrow.

NWC is often misunderstood, but tackling it early with a clear strategy will set you apart as a buyer and improve your chances of closing deals smoothly.

Every deal presents unique challenges, but mastering NWC will make you a stronger, more confident negotiator. If you're serious about buying a business, these insights will help you stand out and close with success.

Have questions or war stories about NWC? Hit reply—I’d love to hear your thoughts.

Happy hunting!

Eric

M&A Lawyer

Publisher, Freedom Through Acquisition Newsletter

​