How does working capital affect your business sale?
For Canadian owners selling a $10 to $50 million revenue company through a broadly marketed M&A process, working capital is a critical concept that surfaces in the buyer's Letter of Intent (LOI) — specifically, the requirement to leave a target amount of working capital in the business in a share sale structured on a debt-free, cash-free basis.
What is working capital? It is the difference between current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, accrued expenses, short-term debt): Working Capital = Current Assets − Current Liabilities. It reflects your short-term financial health and your ability to pay suppliers, manage payroll and fulfill customer orders.
Why does the LOI specify it? A share sale is typically debt-free (interest-bearing debt paid off at closing) and cash-free (excess cash removed by the seller before closing). To keep the business running, the LOI sets a target or "normalized" working capital that must remain at closing. This matters for:
- Operational continuity — the business keeps operating without an immediate cash injection from the buyer
- Historical benchmarking — the target is usually a 12 to 24 month average of past working capital
- Protecting buyer value — the price assumes a normal level, so stripping working capital out reduces value
- Adjustment mechanism — a working-capital adjustment clause trues up the price: deliver above target and the buyer pays more; deliver below target and the price is reduced
Why is it a focal point in a competitive process? Multiple bidders scrutinize working-capital trends in due diligence, may use the target as negotiation leverage, and rely on a normalized figure for apples-to-apples comparisons.
What should sellers do? Work with your M&A advisor to set a normalized target, review financials with your accountant, manage receivables, payables and inventory to historical norms, read the LOI's definitions and adjustment terms carefully, and plan how much excess cash to extract before closing.
Example — on a $20M-revenue manufacturer with a $2M historical working-capital level and a $15M offer: deliver exactly $2M and no adjustment applies; deliver $2.5M and the buyer pays an extra $500,000; deliver $1.5M and the price drops $500,000.
Key facts: working capital in a business sale
Working capital = current assets − current liabilities; the LOI sets a target to remain at closing
Share sales are typically debt-free, cash-free; the target is normalized over a 12 to 24 month average
A working-capital adjustment clause raises or lowers the price versus the target
Sellers should normalize receivables, payables and inventory and plan cash extraction with advisors
Disclaimer: This article is for general informational purposes only and does not constitute legal, tax or financial advice. Consult qualified advisors regarding your specific circumstances.
