Working capital after an acquisition: funding the business from day one

Acquisition working capital is funding put in place at or around completion so the acquired business can pay wages, suppliers and overheads while it waits for customers to pay. It is separate from the money used to pay the seller, though it is usually arranged at the same time and sometimes with the same lender.

Most UK deals are priced on a "cash-free, debt-free" basis. The seller keeps the cash in the business and repays its debts, and the buyer pays for the business with a normal level of working capital in it. In practice that leaves the company with debtors, stock and creditors, but little or no money in the bank on day one. If the target previously relied on an overdraft or an invoice finance facility, that facility usually ends at completion because it was granted to the old owners, or because the buyer's lender requires its security to be released.

The gap is filled by one or more of these, set up to start on the completion date:

• Invoice finance on the acquired sales ledger. A new facility that advances against the target's existing debtors and every new invoice raised after completion. See our invoice finance hub.
• A revolving credit facility. A limit the business can draw, repay and redraw as cash needs rise and fall.
• Stock or trade finance. For businesses that buy inventory in advance of sales, through stock finance or trade finance.
• A term working capital loan. A fixed sum repaid over an agreed period, useful for a one-off need such as integration costs.

Working capital after an acquisition is often tight because the deal mechanics, the change of ownership and integration costs all draw on cash at the same moment, and forecasts built from the seller's history rarely capture this. The common pressure points are:

• The working capital adjustment. Under completion accounts, the price is adjusted if working capital at completion is above or below an agreed "normal" level. Under a locked box, the price is fixed from an earlier balance sheet date and the buyer bears trading after it. Either way, a seasonal business bought at the wrong point in its cycle can need more cash than expected.
• Supplier terms. Suppliers often review credit limits when ownership changes. Credit insurers may cut limits on the business until they see accounts under the new owner.
• Asset purchases. If you buy the trade and assets rather than the shares, the debtors may stay with the seller. The new company starts with no ledger to fund and must wait for its first invoices to be paid.
• Integration costs. Systems, rebranding, professional fees, redundancy or recruitment costs, and any overlap where the seller stays on as a paid consultant.
• Deferred consideration. Staged payments to the seller come out of the same cash flow. Our guide to deferred consideration explains how these are structured.

Illustration only. The figures are round and hypothetical. A buyer acquires a distribution business on a cash-free, debt-free basis. At completion it has £600,000 of debtors on 60-day terms, £200,000 of stock and £400,000 owed to suppliers, but almost no cash. Monthly wages and overheads are £150,000, and the seller's old overdraft is repaid at completion.

A whole-turnover invoice finance facility set up on the completion date might advance a proportion of the approved debtors immediately and then fund each new invoice as it is raised. The buyer's forecast shows that cash would still dip in the second month, when a quarterly VAT payment and the first deferred payment to the seller fall due together, so a modest revolving facility is added for that peak. Without the plan, the business would have needed to delay suppliers in its first quarter under new ownership.

It suits buyers of trading businesses that sell on credit terms, hold stock, or have uneven cash flow through the year, and where the purchase funding alone leaves no headroom.

• Business-to-business companies with a sizeable debtor book, such as distribution, manufacturing, recruitment, logistics and services.
• Seasonal businesses bought ahead of their busy period.
• Management buyout and buy-in teams whose purchase debt is sized tightly on profits.
• Groups adding a bolt-on business that will be integrated into existing systems.

It is less relevant for businesses that are paid upfront, such as many retail, hospitality and subscription businesses, where cash sits in the bank rather than in debtors. A buyer whose deal only works if a working capital line is fully drawn from day one may have a pricing problem rather than a funding problem.

Working capital facilities typically take a few weeks to set up for an acquisition, and the critical point is that they must be ready to start on the completion date. Decisions can come within a few working days in straightforward cases, but invoice finance usually also involves a survey or audit of the ledger and legal work to align security with the purchase lender.

The best time to start is when heads of terms are agreed. That leaves room for the lender's checks, the intercreditor arrangements between lenders, and the notices to customers that a disclosed facility needs, without holding up completion.

Working capital lenders take security over the assets they fund: an assignment of debts for invoice finance, a charge over stock for stock finance, and usually a debenture for a revolving facility. Personal guarantees from the incoming directors are common, particularly where the business is newly owned.

When there is also an acquisition lender, the two lenders agree who ranks first over which assets. Invoice finance providers normally want first ranking over debtors; the term lender takes first ranking over other assets. This is documented in a deed of priority or intercreditor agreement. Our guide to debentures and fixed and floating charges explains the terms, and our guide to personal guarantees covers the risks to you.

Costs depend on the type of facility, and the right comparison is the total cost over a realistic year of trading rather than the headline price.

• Invoice finance: a service fee based on turnover or invoices, and a discount charge (interest) on the money actually drawn, usually a margin over Bank of England base rate charged daily. There may also be minimum fees, audit fees and notice-period costs. Prepayments are typically around 80% to 90% of approved invoices on whole-turnover facilities.
• Revolving credit facility: interest on the drawn balance, a non-utilisation fee on the undrawn limit, and an arrangement fee.
• Term working capital loan: interest on the outstanding balance and an arrangement fee, sometimes with early repayment charges.
• One-off costs: legal fees for security and intercreditor documents, and valuation or survey fees.

You can model invoice finance costs with our invoice finance calculator.

There are several other ways to protect cash after a purchase, and the best answer is often a combination.

• Negotiate a higher normalised working capital level, or a price reduction, so more cash or fewer liabilities come with the business.
• Agree that more of the price is deferred, which reduces the cash needed at completion. Our vendor finance guide explains seller loans.
• Release cash tied up in the target's machinery or vehicles through asset refinancing.
• Increase your own contribution. Our guide to the deposit needed to buy a business covers typical expectations.