Who keeps the cash in the bank when a business is sold? There are several options
Written By Adam Yohanan
The cash goes to the buyer, who takes over all bank accounts.
The cash goes to the seller, who keeps or empties the bank accounts before the sale.
Some of the cash goes to the buyer, and some of the cash stays with the seller.
Cash and accounts receivable are part of "working capital," i.e., assets needed to fund the business's day-to-day operations. Also included in working capital is inventory, which can be quickly converted into cash when sold. These three assets – bank accounts, accounts receivable, and inventory – are called "short-term assets" because they can be converted into cash in the short term.
How to calculate working capital in M&A
To calculate working capital, start by adding up all the short-term assets. Once you have the short-term assets, subtract the short-term liabilities, which include expenses that the company will need to pay in the short term. For example, upcoming payroll, lease payments, and vendor invoices are all part of short-term liabilities.
Working Capital = Short Term Assets – Short Term Liabilities
Now that we have defined working capital, the question is, who owns it when a company is sold? The answer is that it can be the buyer, the seller, or, most likely, a combination of the two.
How to divide working capital in M&A
There are generally three ways to divide working capital. Two are easy, and one is difficult, but sometimes makes more sense.
Easy options
The easy options for dividing working capital are as follows:
Give all working capital to the seller
Give all working capital to the buyer
Pros: Both options are easy because they are clean. No calculations are necessary, and both parties understand what will happen to the cash at closing.
Cons: The first option, giving all cash to the seller, is bad for the buyer because the buyer will need to inject some money into the business on day 1 to meet ongoing obligations. This option creates an immediate post-closing liquidity risk for the buyer unless they have an alternative source of working capital. The second option, giving all working capital to the buyer, is also bad for the buyer because the seller can manipulate the working capital before closing the sale, ensuring the buyer still gets next to nothing.
Difficult option
The third option, giving a portion of the working capital to the buyer and seller instead of all to one side, is the most prevalent because it strikes a balance.
When you divide the working capital between the buyer and seller, the calculation starts with a working capital target, which is a set amount of working capital that will go to the buyer. The remainder will go to the seller.
So, if the working capital at closing is $600,000, and the working capital target was $500,000 (the seller overdelivered), then the buyer will pay the seller an extra $100,000 for the business — that’s the working capital adjustment. Similarly, if the working capital at closing was $400,000, a shortfall from the target, the buyer will pay $100,000 less.
Pros: With this methodology, the seller is incentivized to maintain normal working capital because they will get to keep any excess working capital above a certain amount. If the working capital is below the target, the seller will need to pay extra to cover the gap in funds.
Cons: When introducing a working capital adjustment calculation, you open up the risk of litigation. Inevitably, parties will spend money on extra accounting and argue over the calculations.
Adam Yohanan is a transactional business lawyer with extensive experience representing companies, investors, and entrepreneurs in a wide range of high stakes business transactions.
Adam handles the small and large transactions in the life of a businesses, including mergers & acquisitions, entity formations, partnerships and joint ventures, investing and fundraising, commercial contracts, and dissolutions. His office can be reached at 212-859-5041.
Haley Kopp is a corporate lawyer focused on representing start-ups and small companies in formations, venture capital, angel investor financings, mergers and acquisitions, and general corporate matters.
Haley's diverse experience gives her a practical approach to solving complex business issues, whether guiding companies through financing rounds or corporate transactions. Her office can be reached at (619) 512-3652.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
