Don’t Get Married to Your AR: Why Buyers Retain Accounts Receivables in an M&A Transaction
One of the biggest surprises for sellers during the early stages of a potential sale is learning that buyers will retain their company’s accounts receivables (AR). Most sellers have never considered this aspect of a transaction, and it can be confusing at first. For many, this can feel like they’re walking away with less than the purchase price they were offered. Let’s break down this misconception, explain why buyers retain AR, and discuss why it’s an essential part of M&A transactions.
Accounts Receivables and Net Working Capital
To understand why buyers retain AR, it’s important to briefly cover Net Working Capital (NWC). For a more in-depth discussion on NWC, check out the video on our website where we explore this topic in detail. NWC represents the operational liquidity of a business and is typically defined as current assets minus current liabilities. Components of NWC for staffing companies often include:
- Current assets: Accounts receivables, prepaids, and security deposits.
- Current liabilities: Accrued payroll liabilities, accounts payable, and other short-term accrued liabilities.
Accounts receivables—essentially money owed to the business for services already delivered—are one of the largest components of NWC in staffing companies. Buyers retain NWC, including AR, because it’s necessary for the business to continue operating seamlessly post-transaction. Some sellers perceive this as buyers getting “free financing” for the purchase price, using the company’s own NWC to fund the transaction. This perception often leads to pushback, so we’ll clarify below.
Why Buyers Retain Working Capital
In an M&A transaction, buyers expect the business to come with a “normal” level of NWC—enough to maintain operations without disruption. How a “normal” level of NWC is determined is a separate topic, but the key reasons for retaining it include:
- Operational Continuity: Retaining AR allows the buyer to collect on receivables and use that cash to pay for ongoing expenses, such as payroll, rent, and vendor payments. Sellers often view this as the buyer leveraging their own NWC to fund operations, which can feel like a financing mechanism, but it’s a necessary part of ensuring operational stability.
- Fair Valuation: The purchase price reflects the assumption that the business will include the necessary NWC to operate, meaning AR retention is already factored into the valuation and deal structure. If the seller were to retain AR, the buyer would reduce their offer accordingly.
- Avoiding Immediate Investment: Without NWC, the buyer would need to inject additional funds into the business immediately after closing to cover day-to-day expenses. This translates to additional purchase price to the seller.
It’s also important to note that the buyer does not disproportionately benefit from retaining AR. There will always be an ongoing AR balance while the business is active, ensuring liquidity for operations rather than a one-time gain for the buyer.
A Hypothetical Example
Let’s say a staffing company, ABC Staffing, has:
- $1 million in AR
- $500,000 in accounts payable
- A “normal” NWC level of $500,000.
The buyer offers $10 million for ABC Staffing, assuming the company will include $500,000 in NWC. If the seller wanted to keep the AR, the buyer would adjust the purchase price downward to account for the missing liquidity. In this case, the adjusted price would be $9.5 million—reflecting the true operational state of the business.
Conclusion
While it’s understandable for sellers to feel that AR should remain with them after a sale, it’s important to see the bigger picture. Accounts receivables are part of the operational liquidity that ensures the buyer can seamlessly continue running the business post-transaction. By preparing for this reality and working with experienced advisors, sellers can maximize their transaction value and ensure a smooth and successful sale process.
At Momentum Advisory Partners, we take time to educate our clients on the not so obvious concepts of a transaction so there are no surprises. Given the complexities of NWC and how it’s treated, it’s one of the areas we spend the most time on with clients well in advance of a transaction. That’s why we consistently preach the importance of preparation before entering a sale process. It’s the only way to set realistic expectations.