In certain transactions, it may be feasible to agree on a formulaic approach up-front so as to avoid any
post-closing or calculation disputes. Such a formula would assign a certain percentage credit to the working
capital depending on the aging schedule for the receivables. For example, all receivables less than 30 days
old would receive 90% credit in working capital, 30-60 day receivables would be credited 75%, 60-90 day
receivables – 50% and over 90 days – no credit. While a formula such as this brings certainty in connection
with the net working capital calculation, it may or may not provide the Seller with adequate credit for its
receivables depending on how the formula is structured.
A more typical approach is to value the outstanding receivables less an appropriate reserve for doubtful
accounts. Reserves for receivables may be specific or general. A general reserve is established to account
for the typical experience of the business with respect to un-collectibles. It is important to understand the
historical methodologies for establishing these reserves so that as business metrics change, the necessary
changes in the reserves can be monitored. For example, if a reserve is established based on a percentage of
revenue, as revenues increase, the reserve should increase as well. Specific reserves for receivables are
generally established once an account is known to be in trouble. At that point, the general reserve should be
adjusted for such account and a specific dollar reserve set up to track the troubled account.
In the event that a formula is not used, the provision regarding working capital should deal specifically with
the effect that post-closing collections of receivables will have on the calculation of working capital,
particularly collections that occur prior to the time that any post-closing adjustment is finalized. Seller will
want credit for post-closing collections, especially if those receivables were included in the reserve.
Depending on the length of time post-closing, Buyer may take the position that the collection was due to
Buyer's efforts and, as a result, should not be credited to Seller in working capital. From a Buyer's
perspective, the purchase agreement should specifically provide that collections after closing, or a certain
specified date, should be omitted from the net working capital calculation. Seller's may prefer to remain
silent on this issue or provide that until working capital is finalized post-closing, that it will receive credit for
all collections.
Accounts Payable
While inventory and accounts receivable are generally the largest asset components of working capital,
accounts payable is the largest liability component. The struggle between Buyers and Sellers with respect to
accounts payable is usually over the fact that Sellers desire to clear their plates of all payables and have
Buyers assume all payables on the books as of Closing. Buyers only want to assume liabilities related to the
acquired business and only those liabilities for which they receive credit in the calculation of the working
capital.
Determining which payables to include in the calculation of working capital becomes more difficult when a