Limiting the liability associated with the Seller’s company. By establishing a new company (Newco), specific assets, and liabilities transfer to this new entity. Typically, the Buyer and the Seller work together during this transfer as it’s in their mutual interest for a transition is smooth for the customers, employees, and vendors. An asset sale is the most common type of small business acquisitions. During the transition, it’s important to ensure there is enough working capital to maintain both businesses.
“The Buyer is buying certain assets and sometimes certain liabilities from the Seller.”
During the transition, it is vital to ensure that Newco has the appropriate level of working capital to pay its obligations from the old company and Newco. Specifically, the sale should not negatively impact employees and vendors.
For Example: The closing happens on the 1st of the month, and the first payroll is on the 15th. Newco must have the cash available to make payroll even though Newco has not invoiced any customer and therefore not collected any funds before the 15th.
Let’s keep it simple, even though there may be a few other small accounts, let’s assume that this is the typical formula. For a small company, working capital is the combination of Cash + A/R + Inventory – A/P.
Usually, the cash on hand as of the day of closing goes to the Seller. Both the Seller and the Buyer could argue the A/R goes to them.
Seller: Receivable, as of closing relate to sales done before the closing and, therefore, belong to the seller.
Buyer: In as asset sale, the A/R is an asset just like fixed assets, and therefore it belongs to the Buyer.
Part of the due diligence effort should identify alterations to all of the working capital accounts. For example, a typical scenario is past due collection amounts that show up in the last two columns of the A/R aging. After discussions with the Seller, the A/R is usually adjusted downward by the amount deemed not collectible. Similarly, completing a physical count of goods can also change the inventory. All of these adjustments should reduce the purchase price.
There is a typical adjustment period (60 to 90 days after closing) in which both parties settle any differences in the working capital. For example, let’s assume that the 5,000 of A/P (related to a liability that the Buyer is assuming) was paid after closing but not included in the original working capital listing. In this case, the Seller should reimburse the Buyer for this amount. Generally, all of the adjustments combine into one settlement payment.
Many variations, schemes, and formulas can make this discussion very complicated. In the spirit of keeping things simple, I always go back to the fact that if it is an asset sale, the Buyer should be entitled to most of the working capital items as of the transfer date.
