Selling Your NJ Business? Here’s How Working Capital Impacts Your Deal

By: Fred Petito, CM&AA, CEPA

For New Jersey business owners considering the sale of their company, understanding working capital is crucial for successfully navigating the transaction. Buyers and sellers often negotiate a working capital target as part of the deal structure, and differing expectations can result in disputes, post-closing adjustments, and unnecessary complications.

For lower middle-market businesses, working capital plays a critical role in ensuring operational continuity after a transaction. This article defines working capital, explores its key components, explains how to negotiate a working capital target, and outlines potential post-closing adjustments to prevent issues and disputes.

What Is Working Capital In a Business?

At its core, working capital is a measure of a company’s short-term financial health and operational liquidity. It reflects the difference between current assets and current liabilities and is essential for funding day-to-day business operations.

The standard formula for calculating working capital is:

A positive working capital indicates that a business has more short-term assets than liabilities, meaning it can meet its financial obligations and operate smoothly. A negative working capital suggests potential liquidity challenges, which could be a red flag for buyers.

Key Components of Business Working Capital

Understanding the components of working capital helps sellers anticipate buyer concerns and prepare for negotiations. The primary elements include:

Current Assets

1. Accounts Receivable (AR) – The amount customers owe the business for goods or services delivered on credit.
2. Inventory – Raw materials, work-in-progress, and finished goods available for sale.
3. Prepaid Expenses – Payments made in advance for expenses such as rent, insurance, or supplier agreements.
4. Cash & Cash Equivalents – While typically excluded from working capital calculations in M&A deals, some elements of operating cash may be considered.

Current Liabilities

1. Accounts Payable (AP) – Outstanding payments owed to suppliers for goods or services.
2. Accrued Expenses – Costs incurred but not yet paid, such as wages, taxes, or utilities.
3. Deferred Revenue – Customer payments received in advance for goods or services yet to be provided.
4. Short-Term Debt – Outstanding obligations due within one year.

Negotiating a Working Capital Target in a Business Sale

A key component of deal structuring is negotiating a working capital target to ensure the business functions smoothly post-closing. Buyers typically expect the business to be delivered with a normalized level of working capital, preventing disruptions in operations.

1. Determining the Working Capital Target

The working capital target is typically set based on a historical trailing twelve-month (TTM) average, adjusted for seasonality, business growth, and specific operational needs. Buyers analyze financial statements to determine an appropriate benchmark.

2. Key Considerations in Working Capital Negotiations

• Seller Perspective: Sellers may want to minimize the required working capital target to retain more cash at closing.
• Buyer Perspective: Buyers want to ensure the business has enough working capital to maintain operations without requiring additional investment.
• Industry Norms & Seasonality: Businesses with fluctuating working capital needs—such as those with seasonal demand—may require adjustments to the standard calculation.
• Growth Trajectory: If a business is experiencing rapid growth, a higher working capital target may be necessary to support future expansion.

Potential Adjustments to Working Capital Post-Closing

Post-closing adjustments are common even after an agreement on the working capital target. These adjustments help align the final working capital delivered at closing with the agreed-upon target.

1. True-Up Adjustments

A true-up process typically occurs 30 to 90 days after closing, during which the buyer compares the actual working capital at closing against the target amount. If the final working capital exceeds the agreed-upon target, the seller may receive an additional payment. Conversely, if it falls short, the seller might need to refund the difference to the buyer.

2. Exclusions and Disputes

Certain items may be excluded from the working capital calculation, leading to potential disputes:

• Old or Uncollectible Accounts Receivable – Buyers may challenge the inclusion of overdue invoices.
• Obsolete or Slow-Moving Inventory – Sellers may argue that all inventory is necessary, while buyers may apply discounts.
• Deferred Revenue & Prepaid Expenses – Differences in accounting treatment can impact working capital calculations.

To avoid disputes, sellers should ensure clear definitions of working capital adjustments in the purchase agreement and maintain transparent financial records.

Best Practices for Sellers Preparing for Working Capital Negotiations

1. Analyze Historical Working Capital Trends – Review financial statements to identify patterns in working capital fluctuations.

2. Normalize Adjustments in Advance – Adjust for seasonality, extraordinary expenses, and uncollectible receivables before negotiations.
3. Engage an M&A Advisor or Financial Expert – Professionals can help sellers structure negotiations to maximize value and avoid post-closing conflicts.
4. Document Policies & Accounting Practices – Consistent financial reporting can minimize buyer concerns and potential renegotiations.
5. Clarify Post-Closing Adjustment Mechanisms – Ensure the purchase agreement clearly defines how true-ups and potential disputes will be resolved.

Conclusion

Working capital is a critical component of any business sale, directly impacting transaction value, post-closing adjustments, and financial stability. New Jersey sellers in the lower middle market should proactively understand, prepare, and negotiate working capital targets to avoid surprises and maximize deal proceeds. By implementing best practices, engaging professionals, and maintaining transparency, business owners can ensure a smooth transition while securing the best possible terms for their exit.

About Fred Petito, CM&AA, CEPA

Fred Petito, the President and Owner of Transworld Business Advisors of Essex & Hudson Counties, is a Certified Mergers & Acquisitions Advisor (CM&AA) and a Certified Exit Planning Advisor (CEPA). With over 25 years of experience as a C-level executive and senior leader in large multinational firms, roll-up mergers, and startups, Fred has advised both midsized founder-led and large global companies across various industries.

His business training includes a Doctor of Business Administration (DBA) from Pace University and the Executive Development Program at Columbia Business School. Fred previously worked as an attorney specializing in commercial, estate planning, and tax law. In addition to his CM&AA and CEPA certifications, he is a Board-Certified Coach (BCC) and a Certified Leadership Coach.

Disclaimer: No part of this article or its contents is intended to provide tax, financial, or legal advice; any statements regarding these subjects should be regarded as opinions only. All readers are encouraged to seek independent tax, financial, or legal advice from properly regulated sources.