Key takeaways
- A business cannot run on day one without working capital, so the agreement must say who delivers it and how much.
- The working capital target is set from the business's own history, and the adjustment at closing moves real money.
- Sellers who strip receivables and cash before closing, or buyers who demand excess working capital, both create disputes that a clear definition prevents.
- Settle the definition, the target and the adjustment mechanism in the letter of intent, not in the final week.
Working capital is the money a business needs to operate between paying for what it sells and being paid for it. In a sale it becomes a question that owners rarely think about until it costs them: when the buyer takes over, how much cash, inventory and receivables will be in the business, and who is paying for them?
The answer can move the real price by a large amount in either direction. This guide explains what working capital is in a deal context, how the target is set, how the adjustment works at closing, and the mistakes we see sellers and buyers make in British Columbia. Your CPA calculates the numbers. This guide makes sure you understand what they mean.
What working capital means in a deal
In a transaction, working capital usually means current assets needed to run the business, such as receivables, inventory and prepaid expenses, minus current liabilities such as payables, accrued wages and customer deposits. Cash is often excluded and treated separately, and debt is excluded and dealt with in the price. The exact definition is negotiated and written into the agreement, and it matters, because a line included or excluded changes the result.
The reason it needs defining is that a business delivered with no receivables and no inventory is worth less than the same business delivered with a normal level of both. The buyer would have to fund the gap from their own pocket before the first dollar of profit arrives. A price that assumes a normal level of working capital is only fair if a normal level is actually delivered.
Setting the target
The target is the level of working capital the business normally needs. It is usually set by averaging month-end working capital over the past year or more, adjusted for seasonality and for any known changes. A business with strong seasonal swings may need a target that depends on the closing date, since the inventory and receivables in a peak month look nothing like a quiet one.
The seller's CPA and the buyer's CPA should both work through the history and agree on a target before the purchase agreement is drafted. Disagreement about the target is a price negotiation in disguise, and it is better had early. The target also tells the buyer how much of their own money they will need after closing if the business is growing, since growth consumes working capital.
The adjustment at closing
At closing, the actual working capital is estimated and the price is adjusted up or down by the difference from the target. A final calculation follows some weeks later when the books are closed, with a true-up payment in either direction. Most agreements include a process for disputes, usually referral to an independent accountant whose decision is final.
The practical consequences are large. A seller who collects receivables aggressively and runs inventory down before closing to pull cash out will see the price reduced by the shortfall. A buyer who insists on an inflated target is effectively negotiating a lower price. A clear definition and a fair target stop both games before they start.
- Agree the definition line by line, including how inventory is valued and which receivables count
- Set the target from actual history, adjusted for season and known changes
- Define the estimate at closing, the true-up period and the dispute process
- State whether cash stays with the seller or is included, and treat debt separately
- Decide how customer deposits and prepaid revenue are handled, since they are cash the seller holds for work the buyer will do
Mistakes we see in BC deals
The most common is leaving working capital out of the letter of intent. The price is agreed, the parties shake hands, and weeks later the lawyers discover that one side assumed receivables were included and the other assumed they were not. The second is a seller treating the company's cash as their own in the final months, which is understandable but has to be matched by the agreement. The third is a buyer who finances the purchase price but forgets that the first payroll and the first supplier invoices arrive before the first customer payment.
A fourth, specific to businesses with deposits, is forgetting that customer deposits are a liability. A contractor or a travel business delivered with deposits in the bank and work not yet done has received cash for work the buyer will now have to perform.
Getting it right
Put working capital in the letter of intent, even if only as a principle and a method. Have both CPAs agree the target before the agreement is drafted. Write the definition, the adjustment and the dispute process into the agreement in full. And as a buyer, arrange working capital financing for after closing as part of your lender conversation, not as an afterthought.
At BizSell.ca we raise working capital in the valuation and package stage on the sell side, and in the offer stage on the buy side, so it is never a surprise. Call or text (604) 632-4959 if a working capital question is holding up your deal.