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Small Business Acquisitions: What Assets are Typically Included in an Asset Sale?

Recently, I’ve had several discussions with potential buyers regarding business acquisition deal structure. There seems to be some confusion regarding what assets are included in a typical "Asset Sale". This article is my attempt to help alleviate this misunderstanding.

Small, privately owned businesses are typically sold as asset sales as opposed to stock or equity sales. Small is relative depending upon the industry the business operates within according to the Small Business Administration (SBA). For some industries, under 500 employees is small. For others it may be up to 1,500 employees.

For example, if you own a Chicken Egg Production facility (NAICS code 112310) your business could have up to $16.5 million in revenue and be "small". If you own a Sewage Treatment Facility (NAICS code 221320) with revenues up to $31 million, your business is considered small. To determine size eligibility and other factors, an SBA lender will check the list to see if the business qualifies to participate in the SBA lending program.

So, whether it’s a local diner generating $300,000 annually in revenue or manufacturing firm with 500 employees, both are considered small according to the SBA. Generally, these privately owned companies are sold as "asset sales". Although the larger of the small ones, may be sold as an equity or stock sale. Again, it depends upon the needs and desires of the buyer and seller and the deal structure that is preferred.

Why Most Buyers Prefer Acquiring Small Businesses as Asset Sales

An Asset Sale is a transaction in which only certain assets (and perhaps some liabilities) are transferred to a buyer who becomes the new owner of the business. Typically, only the operating assets (assets needed to conduct business operations) are transferred to the buyer.

Large business transactions generally are done as stock or equity sales (although they may also be done as asset sales). In a stock sale, the stock or equity (which includes all assets and liabilities) are transferred to the buyer. This transfer represents the entire equity of the company.

Most buyers of small, privately owned companies prefer to purchase the assets because there is less risk. Purchasing equity means that the buyer assumes all known and unknown liabilities from the beginning of the entity’s existence. In an asset sale, the buyer doesn’t assume any of the seller’s liabilities unless the liability is explicitly identified and the buyer agrees to assume it.

Don’t Expect Working Capital to Be Included in the Sale Price of an Asset Sale

For these privately owned small companies where 100% controlling interest is sold, the Asset Sale Price includes the operating assets of the subject company that typically transfer in an asset sale. Those operating assets include a normal amount of inventory (if the company has inventory), fixed assets which include equipment and vehicles, and intangible assets (such as goodwill).

The seller receives the Asset Sale Price while keeping the balance of any cash in the seller’s bank account, collects the outstanding accounts receivable at the time of sale closing and pays off the accounts payable and long-term debt, if any. What this means is, in this scenario, there is no working capital included in the Asset Sale Price. To include working capital, those working capital assets must be added to the Asset Sale Price. Otherwise, the buyer is asking the seller to take a significant discount on the price which is not likely to happen.

As a prospective business buyer, you are likely thinking: "Business Broker, how can you expect a buyer to purchase and operate a company without working capital?"

You Can Add Working Capital into the Acquisition, But Not For Free

First, let me be clear, I’m not saying you don’t need working capital. You do. Second, you can get working capital in the deal, but you don’t get it for free. Most of the transactions I have done, have not included working capital in the price. Why? Small businesses are priced to exclude cash, accounts receivable, accounts payable, and debt and to transfer on a "cash-free, debt-free" basis. However, you can certainly buy the working capital assets (and assume any liabilities) if you prefer but the price will change.

Generally, buyers are hesitant to buy cash, accounts receivable net of payables. If you choose not to purchase the working capital, the SBA lender will insist on adding working capital to your acquisition loan or perhaps give you a separate operating line for that purpose. So, you have two choices: buy working capital or borrow it.

To illustrate, let’s use an Asset Sales Price of $2,000,000, which includes a normal amount of inventory, equipment, and goodwill. For sake of argument, let’s assume that the business is priced fairly and DOES NOT include working capital in the price.

Example Deal Structure of a Small Business Asset Sale

As a buyer, you really like this business and decide to make a "full-price" offer of $2,000,000. You want the seller to include $300,000 of accounts receivable for working capital.

What does the seller net from this offer? Before I answer that question, let’s first look at what the seller expected to receive by pricing the business to sell at $2,000,000. A price that did NOT include working capital.

What would the seller net if she accepted the buyer’s offer?

See the problem? The Buyer is asking the Seller to take a $300,000 discount on the price. Do you think the seller will accept this deal? Not likely.

Keep in mind that the $2,075,000 "net to seller" is equivalent to selling the company equity. In other words, the Asset sales price of $2,000,000 where the seller keeps the cash, accounts receivable, and pays off the debt and accounts payable nets the same to the seller as if the seller sold the "equity" of the business (which includes the cash, accounts receivable, accounts payable and debt).

See this:

Note: Inventory (a normal amount) and the equipment are INCLUDED in the Asset Sale Value and are not added or subtracted.

Here’s how the buyer should have been structured:

Wait right there, Sheila! Isn’t the buyer spending an additional $300,000? Technically, yes. However, as we discussed previously here, the buyer can either borrow the working capital or buy it. The buyer doesn’t get working capital for free.

To illustrate, let’s look at a "Sources and Uses Analysis" with a "purchase" of accounts receivable included in the price. For simplicity’s sake, I have assumed that the buyer is putting 20% cash down ($460,000). The cash down is calculated on the "total project" which in this case is $2,300,000. The SBA/lender is financing the remaining 80%.

What happens if the buyer chooses to "borrow" working capital rather than buy it? See below for the borrowed working capital "Sources and Uses Analysis". You’ll notice that the cash down and the loan amounts remain the same. Why? Because the "total project" remains the same at $2,300,000.

Isn’t it interesting that buyer puts down $460,000 cash and receives $300,000 cash back as working capital when borrowing? It works out the same in the "purchased working capital" scenario except that the buyer collects the accounts receivable rather than cash from the Bank/SBA lender at closing.

Which deal structure is better? That depends upon the viewpoint of the buyer and seller and what can be negotiated between the parties.

I hope this short article gives some insight as to deal structure when it comes to working capital.

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