This post belongs to a series on Working Capital (see the contents page here).

An agreement on value doesn’t necessarily signal the end of all deal negotiations and troubles. Partisan vendors will likely hand the business over with zero debtors, zero inventory and a mountain of creditors… oh, and no cash, of course. A scenario like this may see you paying millions more for a business than you had originally planned.

As I’ve discussed in a litany of working capital discourses, working capital goes to value. But, it’s not just the value imputed to the business at a particular point in time; it drives the value you’ll actually get when the business is handed over. And, the last thing you want is to base your valuation on favourable working capital terms and receive the business in an opposite state.

The simplest solution is to decide the settlement accounts at the time of valuation. That is, place a few imaginary stakes in the ground and peg your working capital drivers (decide a fixed amount for inventory, debtors, creditors, cash, etc). If at settlement working capital is not equal to the trigger amount, then the purchase price is adjusted on an equal basis ($1 less in working capital leads to $1 downward adjustment to the price paid). Many private equiteers will try to enforce a one-way adjustment,  but as Sergey and Larry say, don’t be evil.

This isn’t a perfect solution. But, it is a solution designed to be communicated upfront with complete transparency. It will avoid most resentment later on because there is a lot less subjectivity. With that said, there will be some subjectivity in deciding the trigger values for the working capital drivers, but ideally you can make a case based on rigorous analysis of the historic financials.

The simple rule is that you value a business as a going concern and so the business should be left to you as a going concern (therefore, not requiring extraneous investment to support working capital after purchase). Make sure you decide early what constitutes a going concern and then stick to your guns.