I received the following question via email:
How do you typically treat cash in a stock sale vs asset sale. A rule of thumb tells me that me on asset sales, the seller typically keeps his cash and receivables, but not always. How about on a sale of 100% of corporate stock, what happens to seller’s cash. The buyer is buying assets and liabilities, and does that meant, that seller’s cash on the books is transferred to buyer? Please let me have your opinion on this matter.
As always, thank you for your input.
Jack (I changed the name – a little)
It depends on size of company, not really asset vs. stock (although small companies are often asset sales). Smaller deals are typically structured so that the seller keeps cash and AR.
Larger deals, especially ones that use EBITDA for the valuation metric (typically $500K in earnings and above), are typically sold with “gas in the car”. That is, they are sold with enough assets to produce the EBITDA that was advertised. This includes current assets like AR and enough inventory. It also includes payables, but not long term debt. Some buyers insist on some cash as part of current assets, others do not. In any case, it is usually not all the cash – just enough to operate the company.
Often a buyer (having already set a price) will calculate a Net Working Capital value that must be present at close. NWC is current assets minus current liabilities (pretty much cash, AR, inventory less payables). Usually this is calculated by taking the past 12 months of balance sheet snapshots and taking an average (and negotiating). This NWC number then “puts a stake in the sand”. The seller can’t then reduce inventory, aggressively collect AR or do anything that reduces the normal NWC before close. On the other hand, if sales go up and AR goes up before the close, he gets credit for that.
How does that work exactly? Well, another “true-up” NWC calculation is done based on the closing date, and is usually done within sixty days. If the NWC is above the target (AR went up, inventory went up, payables went down, etc.) then there is a purchase price adjustment upwards and the buyer would owe more money (or the seller takes home more cash). If the NWC true-up calculation shows that the NWC at close was below the target (AR was down, inventory down or payables up), then there would be purchase price adjustment downward. More cash would have to be left in the company, or money would be taken from a holdback escrow account.
This all makes sense too if you think about it. For example, if a seller accidently pays off ALL debt, including accounts payables, before close, the NWC calculation would show that the buyer would owe him for that, because that was part of the WC calculation. On the other hand, if the seller calls up a few large accounts to get them to pay their bill before close, the average AR would be down and he would be dinged on the purchase price.
Why would a buyer care so much about about AR and inventory? Because they expect to have paid a certain price for the company, and if inventory and AR are down then over the next 60 to 90 days the buyer will discover that he actually paid more as AR and inventory come back up to normal levels.
This can be a big deal, so it is usually wise to address NWC early so the seller knows what is expected at close.
So…to get back to the original questions. You have a price and you have a NWC target for close. Then, whether asset or stock sale, you make it happen. That is, you create the purchase price allocations for an asset sale, or a stock price calculations for a stock sale. But the basic purchase price and net working capital calculations are the same.
(Having said that, Asset vs. stock sales can profoundly change the tax impact of the buyer and the seller. So often the purchase price is indeed different, based on taxes)
Hope this helps, Ney