Most private company deals are priced on a cash free debt free basis with a normal level of working capital delivered at closing. Both halves of that sentence move real money, and a seller who has never tracked a working capital number can lose a large sum to a mechanism they did not argue about.
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What a cash free debt free transaction means
The price assumes the business arrives with no cash and no debt. At closing your cash is yours and your debt is repaid out of the proceeds, so the headline price is not what you receive. It also means the definition of debt matters: buyers try to include items such as unpaid taxes, deferred capital spending or accrued bonuses as debt like items, and each inclusion reduces your proceeds.
How the target, or working capital peg, is set
Usually from an average of monthly working capital over a recent period, chosen to represent a normal level. That choice is negotiable and consequential: a period that includes an unusual build up of stock or receivables sets a target you must then deliver. Ask to see the calculation, agree the months used, and agree what is included in the definition.
The true up
Actual working capital at closing is compared with the target and the price is adjusted up or down for the difference. Agree who prepares the closing statement, how disputes are resolved and by when, and whether there is a collar within which no adjustment is made. Settling all of this in the letter of intent is worth more than arguing it afterwards.
Questions people ask about target working capital
What happens to cash when selling a business? Is it mine?
On a cash free debt free basis, yes, the cash is yours. Make sure the definition of cash does not exclude balances you consider yours, such as customer deposits.
What is a debt like item?
Anything a buyer argues is really borrowing: unpaid taxes, accrued bonuses, deferred capital expenditure, customer prepayments. Each is negotiable and each should be listed in the letter of intent.
Is a collar normal?
It is common and it is worth asking for. A small band within which no adjustment is made removes arguments over immaterial differences.