Working Capital in a Business Sale | Pulse

In short: Working capital is the money tied up in running the business day to day, the stock, the amounts customers owe you and the amounts you owe suppliers. In a sale it becomes a separate negotiation from the headline price, because a buyer expects to receive the business with enough working capital in it to keep trading normally from the day they take over. If the level at completion differs from the level agreed, the price is adjusted up or down accordingly. Sellers who have not thought about this until the offer arrives frequently find that the amount they actually receive is not the amount they agreed.

This is the part of a transaction owners understand least and the part that most often moves money at the last moment. It is worth understanding before you are in it.

Why does working capital form part of the price?

Because a buyer is acquiring a trading business, not a set of accounts.

Almost every sale is agreed on the basis that the buyer receives the company with no cash and no debt in it, with those balances settled or accounted for separately. What cannot be stripped out is the working capital, because the business stops functioning without it. There has to be stock on the shelves, customers who owe money, and normal supplier terms in place.

So the buyer says, in effect, that the price assumes a normal level of working capital in the business at completion. Deliver more than that and the price goes up. Deliver less and the price comes down. The logic is straightforward. Establishing what normal means is not.

What is a working capital adjustment?

It is the mechanism that compares the working capital actually present at completion against the level the parties agreed as normal, and adjusts the consideration by the difference.

The agreed level is usually called the target, or the peg. Setting it is a negotiation informed by the trading history of the business, and both sides have an obvious incentive to pull it in opposite directions. A buyer wants the target set high, because anything below it reduces what they pay. A seller wants it set low for the same reason in reverse.

What makes this genuinely difficult rather than merely adversarial is that most businesses do not have a single normal level. Working capital moves with the seasons, with the timing of large invoices, with stock cycles and with how hard anyone happens to be chasing debtors that month. Choosing which period to average, whether to strip out unusual items, and how to treat balances that are technically current but practically dead is where the judgement sits. It is also where a seller without their own adviser tends to accept a definition drafted entirely for the buyer's benefit.

How is the completion position measured?

Two mechanisms dominate, and they allocate risk differently.

Completion accounts. A set of accounts is prepared after the deal closes, showing the actual position on the day of completion. The adjustment is calculated from those figures and the price is settled afterwards. It is accurate, and it means the final amount is not known on the day you sign.

Locked box. The parties fix the position at a date before completion, using accounts both sides have already seen, and the price is set from that. The seller then undertakes not to extract value from the business between that date and completion beyond agreed permitted items. There is no adjustment afterwards, so the seller knows the figure at signing.

Neither is inherently better for a seller. Locked box gives certainty and shifts trading risk to the buyer for the intervening period, which is why buyers resist it in volatile businesses. Completion accounts give accuracy and leave the seller exposed to a calculation performed after they have lost control of the company. Which one suits you depends on the business, the timescale and how confident you are in the numbers.

Why do sellers lose money here?

Because the adjustment is technical, it arrives late, and by the time it bites the seller has usually stopped negotiating.

The common patterns are consistent. A target set from a period that flattered the buyer. Debtor balances that will never be collected still counted as assets until the buyer excludes them at completion. Stock valued on a basis nobody scrutinised until it mattered. Accrued costs the seller did not think of as working capital being pulled into the definition. Deferred income treated as a liability that reduces the price, on contracts the seller regarded as won revenue.

None of these are sharp practice. They are the consequence of a definition drafted by one side and accepted by the other without testing what it does across a full trading cycle.

What can a seller do about it?

Understand your own cycle before anyone asks. Know how your working capital moves through the year and why. If you cannot explain the pattern, you cannot argue about the target.

Clean up before you go to market. Collect what is collectable, deal with the balances that are not, and value stock on a basis you can defend. This takes time and cannot be done during a transaction.

Keep reporting that stands up. A buyer's adviser will test the numbers against the underlying records. Weak reporting hands them the argument. Our guide to what financial information buyers need covers what they will ask for.

Get the definition looked at, not just the target. Which balances are included matters as much as the number itself, and the definition is where value quietly moves.

Take advice before you agree heads of terms. The mechanism is usually settled at that stage and treated as fixed afterwards, even though it is rarely discussed as carefully as the price.

The underlying position also feeds the valuation itself, since a business that consumes working capital as it grows is a different proposition from one that generates cash. Our business valuation services set out how that assessment works.

How does this fit into preparing for sale?

It is one of the areas where preparation converts directly into money kept, and one of the few where the work is unglamorous and entirely within your control.

Tightening credit control, resolving old balances and reporting on the position regularly are all things a business benefits from whether or not it ever sells. They also happen to be exactly what removes the buyer's easiest arguments. Our business advisory service works on this with owners well ahead of a transaction.

For a view of where your business currently stands across the areas that decide a sale, the Exit Readiness Scorecard  works through them. For the wider process, see our guide to business exit planning.

FAQs

What is working capital in a business sale?

Working capital is the money tied up in day to day trading, principally stock, amounts owed by customers and amounts owed to suppliers. In a sale it is treated separately from the headline price, because the buyer expects to receive a business carrying enough of it to continue trading normally without injecting funds immediately after completion.

What is a working capital adjustment?

A mechanism that compares the working capital present in the business at completion against an agreed target, and adjusts the price by the difference. Deliver more than the target and the consideration increases. Deliver less and it reduces. It is standard in company sales and it is negotiated rather than calculated by a fixed rule.

How is the working capital target set?

By reference to the trading history of the business, usually by averaging the position across a period both sides accept as representative. The difficulty is that most businesses fluctuate through the year, so which period is chosen, and which items are stripped out as unusual, materially changes the outcome. It is a negotiation informed by evidence rather than an objective figure.

What is the difference between completion accounts and a locked box?

Completion accounts measure the actual position on the day of completion and settle the price afterwards, which is accurate but means the final figure is unknown at signing. A locked box fixes the position at an earlier date that both parties have already reviewed, so the price is certain at signing, with the seller undertaking not to extract value in the intervening period.

Can the working capital adjustment reduce what I receive?

Yes, and it commonly does. If the business holds less working capital at completion than the agreed target, the consideration reduces by the shortfall. Because the calculation often happens after completion, sellers can find the final amount lower than the figure they agreed without having done anything wrong.

Is cash included in working capital for a sale?

Usually not. Most deals are structured on the basis that the buyer acquires the business with neither cash nor debt, with those balances dealt with separately. Working capital covers the trading balances. How individual items are classified is defined in the agreement, and that definition is worth reading carefully.

Should I collect outstanding debts before a sale?

Yes, and well in advance. Aged balances that will not be collected are usually excluded by the buyer at completion, which reduces the working capital delivered and therefore the price. Resolving them early means you either recover the money or stop carrying it as an asset you will not be paid for.

When is the working capital mechanism agreed?

Normally at heads of terms, before detailed negotiation begins, and it is treated as settled from that point. That is earlier than most sellers expect, and it is the reason advice taken at the offer stage is worth considerably more than advice taken once lawyers are drafting.