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What Happens to Cash When Selling a Business?

The fate of cash during a business sale isn’t as straightforward as simply handing it over to the buyer or pocketing it all yourself. It hinges on the specific terms meticulously outlined in the purchase agreement, the type of deal structure (asset sale versus stock sale), and, critically, how working capital is handled. Generally, in an asset sale, the seller usually retains the cash. Conversely, in a stock sale, the cash transfers with the company to the buyer, unless specifically excluded in the agreement.

Navigating the Cash Conundrum: A Detailed Look

Selling a business is a complex undertaking, and understanding the intricacies of cash handling is crucial for both the seller and the buyer. It’s not merely about who walks away with the money; it’s about ensuring a fair and equitable deal, a smooth transition, and minimizing potential disputes down the line. Let’s delve into the key factors that determine where the cash ends up.

Asset Sale vs. Stock Sale: The Deciding Factor

The type of transaction structure is paramount.

Asset Sale: In an asset sale, the buyer is purchasing specific assets of the business – equipment, inventory, customer lists, intellectual property, and so on. The legal entity (the company itself) remains with the seller. Because the buyer is cherry-picking the assets they want, the seller typically retains all assets not explicitly included in the sale, including cash. This allows the seller to pay off liabilities, distribute profits, or reinvest the cash as they see fit.
Stock Sale: In a stock sale, the buyer acquires the ownership of the entire company, purchasing the shares held by the existing shareholders. Consequently, the buyer inherits everything within the company, including its assets, liabilities, and, crucially, its cash. In a stock sale, the buyer is buying the “whole enchilada.”

The Working Capital Adjustment: A Critical Element

While the asset sale vs. stock sale structure provides a general framework, the working capital adjustment is where the rubber meets the road. Working capital represents the difference between a company’s current assets (like cash, accounts receivable, and inventory) and its current liabilities (like accounts payable and short-term debt).

Why is Working Capital Important? Buyers need to ensure the business has sufficient working capital to operate smoothly after the acquisition. A business starved of working capital can quickly run into operational difficulties.
The Adjustment Mechanism: Typically, the purchase agreement will specify a target working capital level. This represents the agreed-upon amount of working capital the business should have at closing. If the actual working capital at closing is higher than the target, the buyer will pay the seller an additional amount to compensate for the excess. Conversely, if the actual working capital is lower than the target, the seller will reduce the purchase price to compensate the buyer. This adjustment ensures the buyer receives a business with adequate cash and short-term assets to operate effectively.
Cash as Part of Working Capital: Cash is, of course, a key component of working capital. Therefore, how cash is treated directly impacts the working capital adjustment.

Negotiating the Cash Position: A Delicate Dance

The treatment of cash and working capital is often subject to intense negotiation.

Seller’s Perspective: Sellers generally want to retain as much cash as possible, particularly in an asset sale. They may argue that the agreed-upon purchase price already reflects the value of the business and that the cash is rightfully theirs.
Buyer’s Perspective: Buyers want to ensure they acquire a business with adequate working capital. They may push for a higher target working capital level or argue that the cash is essential for funding ongoing operations and future growth.
The Role of Due Diligence: Thorough due diligence is crucial for both parties. The buyer needs to carefully analyze the historical working capital levels of the business to determine an appropriate target. The seller needs to be prepared to justify their cash position and demonstrate the financial health of the business.
Locked Box Agreements: A “locked box” agreement freezes the cash and working capital at a specific date (the “locked box date”). The buyer receives the benefit of any earnings generated by the business after the locked box date, but also bears the risk of any losses. This provides certainty regarding the cash position at closing but requires careful consideration of potential risks.

Beyond the Basics: Other Considerations

Transaction Expenses: Remember that the seller will typically incur transaction expenses (legal fees, accounting fees, broker fees, etc.) related to the sale. These expenses will often be paid out of the business’s cash balance before the final distribution of proceeds.
Debt Repayment: If the business has outstanding debt, the purchase agreement will specify how that debt will be handled. Often, the seller will be responsible for repaying the debt from the sale proceeds, potentially impacting the amount of cash they retain.
Tax Implications: The treatment of cash and the overall deal structure have significant tax implications for both the buyer and the seller. It is crucial to consult with tax advisors to understand the tax consequences of the transaction.

Frequently Asked Questions (FAQs)

1. In an asset sale, can the buyer demand that I leave a certain amount of cash in the business?

It’s unlikely the buyer can outright demand you leave cash. However, they can negotiate a working capital target. If the actual cash balance (along with other current assets) at closing is below that target, the purchase price will be reduced. This effectively means you’re leaving cash in the business.

2. What happens to cash in the business bank accounts if I sell the company stock?

When selling the stock of your company, you are selling the entire entity, including all assets and liabilities. The cash in the business bank accounts is transferred to the buyer as part of the deal, unless you specifically negotiate an exclusion for it in the purchase agreement.

3. What’s the difference between “cash” and “working capital”?

Cash is simply one component of working capital. Working capital is a broader measure, representing the difference between current assets (including cash, accounts receivable, inventory) and current liabilities (accounts payable, short-term debt).

4. How is the target working capital level determined?

The target working capital is typically determined by analyzing the historical working capital levels of the business, considering industry benchmarks, and projecting future operational needs. Due diligence is crucial for accurately assessing this.

5. What if the actual working capital at closing is significantly different from the target?

Significant deviations from the target working capital can lead to disputes. The purchase agreement should specify a mechanism for resolving these disputes, such as a post-closing adjustment or an arbitration process. A material adverse change (MAC) clause could come into play if the decrease is substantial.

6. Can I simply transfer cash out of the business before closing?

While you can technically transfer cash out before closing, doing so without proper disclosure and agreement can be a major breach of contract. The buyer may have grounds to reduce the purchase price, sue for damages, or even walk away from the deal. Transparency is key.

7. What is a “cash-free, debt-free” deal?

In a cash-free, debt-free deal, the seller removes all cash and debt from the business before closing. The buyer pays a price based on the enterprise value of the business, without taking on any cash or debt. A working capital adjustment is still typically applied to ensure the buyer has sufficient operating funds.

8. What happens to cash held in escrow?

Cash held in escrow is usually related to indemnification clauses for potential breaches in the purchase agreement representation and warranties. If no claims are made within the agreed upon time frame, those funds are released to the seller.

9. How does the sale of a sole proprietorship affect the cash balance?

Selling a sole proprietorship is structured as an asset sale. You would typically retain the cash unless you and the buyer explicitly agree to include it in the sale. The main difference is that the assets were never legally separated from you, the individual.

10. Should I consult with an attorney and accountant before selling my business?

Absolutely! Selling a business is a significant transaction with complex legal and financial implications. Consulting with experienced attorneys and accountants is essential to protect your interests, navigate the complexities of the deal, and minimize potential risks.

11. How do earnouts affect the amount of cash I receive upfront?

Earnouts are contingent payments based on the future performance of the business. While they can increase the total purchase price paid to the seller, they typically reduce the amount of cash received upfront.

12. How are retained earnings affected when selling a business?

In an asset sale, retained earnings stay with the selling entity. In a stock sale, retained earnings transfer to the new owner along with all other assets and liabilities of the company, unless you specifically negotiate an exclusion.