Why it matters
Payables (creditors in UK accounts) are the bills a business owes its suppliers. A seller who pays those bills more slowly in the months before a sale keeps more cash in the bank. Share sales (stock sales in the US) are often agreed on a cash-free, debt-free basis, so the seller takes that cash out at completion. You are left with the unpaid bills and have to settle them from your own funds soon after you take over.
The effects go beyond cash. Suppliers who have been kept waiting may shorten credit terms, ask for payment upfront or stop supplying just as you are settling in. In a share sale, any late payment charges stay in the company too. In an asset sale, payables usually stay with the seller, but suppliers may still be wary of the new owner.
Taxes can be stretched in the same way. VAT, sales tax and payroll taxes held back to boost cash can carry interest and penalties (see unpaid taxes a buyer could inherit).
This flag is usually fixable, provided you find it before you sign. A working capital peg, set at the level the business normally needs, reduces the price if payables are above normal at completion. Completion accounts, or a locked box with suitable protections, can do a similar job. Base the normal level on a representative period, such as an average across the last year, rather than the month just before the sale. An accountant can help you set it.
In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.
Cash-free, debt-free is a pricing basis in which the headline price assumes the business changes hands with no cash and no borrowings. The seller keeps the cash, repays the debt and leaves a normal level of working capital behind.
A working capital peg is the agreed level of working capital a business must contain at completion. The price moves up or down by the difference between the actual figure and the peg.
How to spot it
- Payables are higher than in the same months last year, while purchases are not.
- The number of days the business takes to pay suppliers has risen over recent months.
- The aged creditors report shows more balances overdue by 60 or 90 days.
- The cash balance is rising faster than profit would explain.
- Supplier statements show higher balances than the ledger, or include reminders and final demands.
- There is a payment plan with the tax authority, or tax returns show amounts owed but not yet paid.
Questions to ask the seller
- What payment terms do your main suppliers give, and are you paying within them?
- Has anything changed in how quickly you pay suppliers this year?
- Is any supplier chasing overdue amounts, asking for payment upfront or refusing to supply?
- Are all VAT, sales tax and payroll tax payments up to date?
- What level of working capital does the business need in a normal month?
- How do you propose to set the working capital level in the sale agreement?
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.
Documents to request
- Monthly aged creditors (payables) reports for the last 12 to 24 months
- Monthly aged debtors (receivables) reports for the same period
- Monthly balance sheets for the last 24 months
- Statements from the five largest suppliers
- Bank statements for the last 12 months
- VAT, sales tax and payroll tax filings, with proof of payment