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Punching Out: Your Financial Preparation for a Sale

When preparing for a sale, it’s important to clean up the financials as much as possible. The fewer questions and the less that needs to be explained, the easier it is to get through due diligence without slowing things down or creating mistrust. Here are the main things that are relatively easy to clean up:

Accounts Receivable
The A/R aging report should show only accounts receivable that are collectible and that aren’t too old. It is better to write off an old A/R than keep it on the books for too long. Banks and buyers will get nervous if A/R over 90 days is above a certain percentage of the total. The exclusion of old A/R from the net working capital (NWC) calculation may necessitate a post-closing adjustment.

Inventory
Sellers should consider the amount of raw materials inventory, components, and finished goods. Buyers are concerned if a company does not have control of these accounts, and banks will not be able to loan against these assets. Many companies have “double-secret” inventories of obsolete components, hard-to-get materials, or finished goods overages. Buyers may not want to pay cash for these assets, but may agree to pay for them post-closing, or during pre-closing horse-trading negotiations.

Other assets that sellers do not always consider are raw materials in plating tanks, such as gold/copper, scrap, drill bits, and difficult-to-obtain spare parts

A note on net working capital: Buyers are always concerned that sellers will manipulate NWC during due diligence. Some owners will: 

1. Tell their customers to pay early and take discounts
2. Stop buying inventory 
3. Rack up payables
4. Stop buying items such as toilet paper and pencils

Buyers get angry if they must inject extra money into the business soon after closing. If you buy a used Pinto, you don’t expect the gas tank to be full, but if you buy a new Mercedes, the gas, oil, and window washing fluid had better be full.

Most letters of intent (LOI) include an NWC adjustment—meaning accounts receivable plus inventory less accounts payable should remain more or less the same from the signing of the LOI (or an agreed-upon date) to the closing of the deal. If the NWC goes up, the seller will receive the difference. If the NWC goes down, the seller will owe the buyer the difference. NWC can go up and down due to regular business fluctuations. The NWC adjustment is meant to keep things fair and also prevent sellers from manipulating NWC. Understanding NWC will make the adjustment process easier and help avoid last-minute shocks.

I don’t recall any buyers counting toilet paper and pencils at closing; however, if these stocks are low on Monday after closing, the buyer will not be happy. This could lead to a lack of trust later, so do everyone a favor and please keep buying toilet paper.

Fixed Assets
Owners often use accelerated depreciation to take advantage of tax write-offs. However, this means the value of fixed assets on the balance sheet is often far below the cost as well as the market value. Keep records of the purchase cost, current market value, and maintenance records of all major fixed assets.

Accounts Payable
Like A/R, clean up the A/P aging report and have an explanation ready for any old A/P.

Loans/notes 
If there are any old shareholder notes, operating leases, PPPs, or other loans, clean those off the balance sheet before showing them to buyers. Ask your attorney to check for expired UCCs or other liens; there usually are.

This entire financial cleanup may take a lot of time. However, by taking one item at a time and performing due diligence on yourself, you can clean them up without too much hassle. If your team does not have the time to count inventory, hire a part-time intern (or your kid, nephew, or grandkid) to do so. The delay in signing an LOI increases pressure, potentially leading to delays and causing mistrust with the buyer.

Tom Kastner is the president of GP Ventures, an investment banking firm focused on sell-side and buy-side transactions in the tech and electronics industries. GP Ventures has offices in Chicago and Tokyo, with five people in total. Tom Kastner is a registered representative of, and securities transactions are conducted through, StillPoint Capital, LLC—a Tampa, Florida, member of FINRA and SIPC. StillPoint Capital is not affiliated with GP Ventures.