In an asset sale, the buyer buys a business’ assets in exchange for the purchase price. Then the buyer gets to operate that business, simple, right? In an asset transaction, the transfer of the “business” is often not as simple as signing a document transferring title to the assets in exchange for the purchase price. Rather, a selling business may have both continuing and outstanding obligations that do not cease, as well as trailing payments for products and services. In other words, a business usually has outstanding accounts receivables and payables. Further, payment of payroll and benefits may not line up with the closing date.
While this is not as simple as buyers and sellers might like, it is also foreseeable for lawyers to address in the purchase agreement as “net working capital.” Net working capital represents the difference between a company’s current debts and assets, and reflects the business’ operational liquidity. In an asset transaction, net working capital is a number agreed upon by the buyer and seller over and above the purchase price. As noted, it reflects the operational practicalities of the business itself rather than the value of the assets. Colloquially, one can think of it as keeping some cash in the cash register to actually operate the business on day one. Like any other material business term, the amount of the net working capital, called the “target working capital,” should be negotiated by the parties prior and addressed in the purchase agreement. At closing, and sometimes for a period of time trailing closing, the parties will look at the net working capital of the selling business. If the actual net working capital is less than the agreed upon target working capital, then the purchase price will be increased to compensate. Alternatively, if the actual net working capital is more than the target, the purchase price is similarly reduced.
The appropriate amount of the target depends on several factors, including the type of business and size of business. Indeed, determining an appropriate target should necessarily include input from the seller and current business owner on how the business operates. In addition, when to determine the true-up for the target, for example, at the closing or some other period afterward (thirty or sixty days), also depends on the details of the particular business.
If you would like further information on asset sales or other business matters, please contact Attorney Joshua J. Butera at 401-824-5100 or email jbutera@pldolaw.com.
