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M&A Smooth Selling: Clean Up the Balance Sheet

One of the biggest obstacles to getting a deal done on a merger or acquisition is a messy balance sheet. Now, don’t freak out about the accounting. Accounting is your friend.

One of the key figures on a balance sheet is the current ratio, or the difference between current assets and current liabilities. Anything labeled current on the balance sheet is essentially the same thing as cash. So what are these cash or almost-cash items?

  • Assets: Cash, accounts receivable, inventory, deposits, and prepaid expenses

  • Liabilities: Accounts payable, accrued expenses (those not yet paid), and the current portion of any loans (interest, and perhaps some principal)

The current ratio measurement is important because if the current liabilities exceed current assets, the company is considered illiquid, which means that if all the current creditors demand immediate payment, the company doesn’t have enough current assets to pay those demands. And if you’re trying to sell a company, that’s not going to endear you to most Buyers.

To fix up your balance sheet in preparation for a sale, follow these steps:

  1. Collect your receivables.

    Buyers check to see whether Sellers are diligent about this collection (at least, they should). If the terms are net 30 (that is, money is due within 30 days), as a Seller you should be collecting those receivables within that time frame. If customers are taking longer to pay, that’s effectively a use of cash.

    Slow collections on receivables may mean Buyer has to obtain a revolver loan, a loan designed to help companies with fluctuations in cash flow. Loans aren’t free; therefore Buyer may demand to reduce the purchase price to help defray the cost of that loan.

    Buyer will likely assume your working capital, namely receivables and payables, as part of a transaction. Buyer will probably want all the receivables but may make you grant a discount on overdue accounts.

    Buyer will also only assume payables if they’re current or within terms. For example, if a vendor gives you net 30 days terms but you’ve been paying net 45 days for years without complaint from the vendor, you can make a case that the actual (or de facto) terms are 45 days.

  2. Make sure inventory is all saleable.

    If you have obsolete or slow-moving inventory, talk to your accountant about how best to write off this inventory. Writing off inventory decreases the company’s earnings, so you want to get this step out of the way before you go through a sale process.

    If you write off any inventory prior to a sale process, you should be able to discuss the rationale you used for those write-offs as well as the steps you’ve taken to prevent future build-ups of excess or obsolete inventory.

    You put yourself in a precarious position as Seller if, during the due diligence phase, Buyer discovers a boatload of obsolete inventory that isn’t reflected on the valuation. In this scenario, Buyer will likely attempt to renegotiate (that is, argue for a different deal, probably with a lower price) because earnings are now effectively lower in light of the inventory the company needs to write off.

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