Working capital, and the month three problem after an acquisition

What working capital funding is

Working capital funding covers the gap between money leaving the business and money arriving. Staff are paid on their timetable, suppliers on theirs, and customers on their own. Almost every trading business has a period each month where it has done the work, paid for doing it, and not yet been paid for it. That period costs money to hold.

It is less a product than a job that several products do, and the right one depends on what the gap is made of.

• An overdraft on the trading account, drawn and repaid as the balance moves.
• A revolving credit facility, which does the same thing with a committed limit and its own agreement.
• Invoice finance, where the gap is caused by a debtor book and the money is advanced against invoices already raised.
• Asset-based lending, where stock and plant are part of the gap as well as debtors.
• A short unsecured business loan, which is quick and priced for being quick.

Why an acquisition makes the gap bigger

This is the part buyers consistently underestimate, and it is the reason so many acquisitions have a difficult month three despite trading exactly to plan.

On completion the salaries become yours immediately. The suppliers' invoices arrive on the normal cycle. But the money owed for work done before completion frequently does not come to you at all, and the first cash you collect is for work you have paid to deliver since the day you took over.

Who owns the debtor book is therefore a first-order question, not a legal detail, and the answer depends on how the deal is done. It is one of the practical differences between the two routes set out in share purchase versus asset purchase. On a share purchase the price usually assumes a normal level of working capital in the business, with an adjustment afterwards once the completion accounts are prepared, so the question becomes what "normal" was agreed to mean and who checked it. On an asset purchase the debtors and the work in progress are commonly excluded or bought separately, which leaves the buyer paying to earn the next month's cash while the seller collects the last month's.

Either way, the honest calculation is straightforward: work out how many days of cost the business has to carry before the receipts start arriving, and fund that. Then add the same again for the fact that acquisitions are disruptive and customers pay slower during a change of ownership, not faster.

How each facility behaves and what it costs

Overdrafts are usually the cheapest way to hold a small, short gap, and they carry the most important caveat in business finance: an overdraft is normally repayable on demand. It is reviewed at intervals, and it can be reduced or withdrawn. Building a business plan on one is building on something that can be taken away in a letter.

A revolving credit facility is committed for a term, which is the difference worth paying for. It carries interest on what is drawn, plus a fee on the part of the limit that is not drawn, plus a renewal or arrangement fee. That non-utilisation charge is what people forget when comparing it with an overdraft.

Invoice finance has two charges rather than one, a discount charge on the money drawn and a service fee on turnover, and it grows with the ledger instead of being resized by application.

Short unsecured loans are fast and the pricing reflects that. The fastest products repay weekly or daily, which is not working capital funding so much as a different kind of pressure on the same cash flow.

Security on any of them is usually a debenture, and a personal guarantee is common on smaller facilities.

What a lender takes comfort from

Less than buyers expect from the accounts, and more than they expect from the forecast. A lender funding working capital is looking for evidence that the business understands its own cycle: how long customers actually take to pay against how long they are meant to take, how much stock sits still, what the seasonal shape is, and what happens to all of that in a quiet quarter.

A weekly cash flow forecast for the first period after completion, built from real payment behaviour rather than from invoice terms, does more to settle a lender than any amount of narrative. It also tends to show the buyer something they did not know.

What goes wrong

The purchase was funded properly and the trading was not. Every pound went into the price and none into running the business afterwards.

The overdraft did not come with the business. Facilities belong to the seller or to the company under its previous ownership, and a change of control usually ends them. A new facility has to be agreed, and it is agreed with a business that has no trading record under its new owner.

The completion accounts adjustment was a surprise. A mechanism nobody modelled produces a payment in one direction or the other, weeks after everyone has moved on.

A structural loss was funded as though it were timing. Working capital facilities cover a gap that closes. If the gap never closes, the facility is postponing a different conversation.

The facility was pulled at renewal. Annual review is a real event, and the moment to have an alternative in mind is before it.

What a lender will want to see

• A cash flow forecast, weekly for the first months and monthly thereafter, with the acquisition debt service in it.
• Aged debtor and creditor listings, and the actual payment behaviour behind them.
• The completion mechanism, and who collects the pre-completion debtors.
• Seasonality, and the worst month of the year rather than the average.
• The acquisition facility, since senior term debt repayments come out of the same cash.

Unfamiliar terms are in the glossary, and where a business is being bought for the first time, the sequence of decisions is set out in the buyer journey.

Getting the gap funded before it becomes urgent

Working capital is easiest to arrange when it is not yet needed and hardest when it is. A business asking for a facility in month three, with no trading history under its new owner and a cash flow that is visibly under strain, is asking a much harder question than the same business asking in the month before completion.

We know this market and we know the people who fund trading cash in the sectors we cover, so the conversation can happen at the point it is cheap rather than the point it is urgent. Tell us what the cycle looks like and we come back to you having spoken to them.