Accounts Receivable and Payable When You Sell a Business
Who keeps what customers owe you and who pays what you owe vendors depends on the deal. Here is how receivables and payables are handled at a sale.
Words by
Matan Michael
On the day you close, your customers will owe you money and you will owe money to your suppliers. Neither of those facts goes away because the business changed hands. What happens to the balances depends on how the deal is built, and owners who do not ask early are often surprised by how much cash they expected and did not get, or how many bills turned up after they thought the business was behind them.
Who ends up with the money customers owe
Start with the structure, because it decides most of the answer. In a typical asset sale of a small or mid-sized business, the buyer purchases the equipment, the customer relationships, the name, the lease and the goodwill, and leaves behind the cash, the receivables and the payables. You collect what you were owed for work already done, and you pay what you owed for goods and services already received. The company's own bank account stays with you. Our post on asset sales versus stock sales goes through the difference.
In a stock sale the company itself changes owners, and everything inside it goes along, balances included. The buyer pays for the business with those balances in it, which is why a stock sale is almost always accompanied by a target for working capital.
Plenty of deals land somewhere between. The buyer may agree to purchase the receivables at a face value less a discount for ones that never get paid. Sometimes the buyer takes the receivables and pays the payables as a package, so the business has what it needs to operate on day one. A buyer who inherits an empty company with no money to buy inventory or meet the first payroll will have a hard first month, and a thoughtful buyer will ask for enough working capital to run, either in the price or in the deal terms.
What a buyer asks to see about receivables
The first request is an aging report, which lists each customer and how long each invoice has been open. Current, thirty days late, sixty, ninety and beyond. Buyers read it for what it says about collection. A report where most of the money is current and a few small accounts are old suggests a business that gets paid. A report with several large balances past ninety days suggests the cash is not coming, and some of those balances are probably never going to be collected.
Expect a few more questions. Is the money owed by many customers or a few? Are any of them related to you? Are any in dispute, or waiting on a credit memo? Are any of them hospitals, governments or large companies that pay late as a habit but pay in full? A buyer who is buying receivables will price each category separately, and one who is not will use the same report to decide how much working capital they need on day one.
If you know a balance is not collectible, write it off before the buyer finds it. It lowers this year's profit slightly, and it saves you a long conversation. It also keeps your statements consistent with your returns, which matters for the reasons we describe in getting financials ready for a buyer.
Retainage and progress billing deserve a word for contractors and anyone who bills in stages. Money held back by a customer until the job is accepted shows up as a receivable, and it may not be paid for months. A buyer will want to know which jobs are open, how complete each is, and who finishes the work. If the buyer finishes jobs you have already partly billed, expect a conversation about how the money from those jobs is divided.
The payables, and the urge to stretch them
Payables are the other side of the report, and the same logic applies. A buyer will ask for the list of what you owe, by vendor, with how old each invoice is.
Owners who are about to sell sometimes stretch their payables in the last few months. Bills that normally get paid in thirty days get paid in sixty. The effect is that cash in the bank looks higher, which flatters the number a buyer sees. It does not work for long. A careful buyer compares payables to the vendor statements and to your usual pattern, and will see that the average age jumped. Vendors also notice, and a supplier who has been paid late is a supplier who may ask a new owner for cash on delivery.
If the structure leaves payables with you, the cleaner path is to pay them down normally and let the cash show what it shows. If payables go to the buyer, stretching them is what shifts value from the buyer to you without telling them, and the buyer's accountant will read it that way. Either way, plain habits are better.
Other obligations behave like payables and are easy to forget. Credit card balances, accrued payroll and vacation owed to staff, sales tax collected and not yet remitted, customer deposits, gift cards and prepaid memberships. A customer who paid you in advance for work you have not done has handed you a debt, and the buyer who takes over the business will be the one doing the work. Expect that to be a point in the negotiation, whether through a credit against the price or a transfer of the cash.
The working capital number
When the buyer takes some balances and the seller keeps others, the agreement usually sets a target for how much working capital the business should have at closing. It is a level based on what the business has needed over the last year, and if the closing day figure comes in short, the price comes down by the difference. If it comes in over, the seller may be paid for the excess. The mechanics are covered in earnouts, holdbacks and working capital.
For the seller, the question that matters is how the target is set. A target that reflects an average of twelve months is fair. A target set from the one month when receivables were highest, usually the buyer's best argument, can cost you a good deal of money. Bring your monthly balances to the table and show the pattern, including the seasonal swings, so the number is argued from data. Your accountant should be involved at this stage, and the definition of each account in the formula should be written down in the agreement.
After closing, when the checks keep arriving
Customers do not know the business was sold on the day it happened. For weeks or months, some of them will keep paying your old account, mail checks to the old address and use the old invoice instructions. The agreement should say what happens to that money. If the receivables stayed with you, the buyer is holding your checks. If the buyer purchased them, you are holding theirs. In both cases someone has to deposit and forward them within a few days, without netting out other amounts, and the agreement should say how quickly.
Decide up front who tells customers what. A short letter on the new owner's letterhead with new payment instructions usually does the job, and it gives you a clean date to point to. If the sale is confidential until closing, the letter goes out after, which is another reason to plan the language beforehand.
Disputes happen. A customer says they never received the goods, or that the work was poor, and holds back payment. If the receivable was yours, you may need the new owner's help to resolve it, since the customer relationship is theirs now. A sensible agreement gives you access to the records and the right to follow up, and a buyer who agrees to that early is usually a buyer who wants to keep the customers happy.
Vendor credit does not transfer by itself
Suppliers extend credit to a company based on its history. When the owner changes, a supplier that gave you thirty day terms may treat the new owner as a new account and ask for a deposit or cash on delivery until trust is built. That ties up cash in the first months, and a buyer who has not planned for it can start out short. It helps if you introduce the buyer to your main vendors during the transition, and a few will write a letter confirming the terms will carry over.
Accounts with a utility, a phone carrier, a payroll provider or a merchant processor often need to be reopened in the buyer's name. The sooner the buyer's attorney and accountant have the list, the less likely a service gets turned off the week after closing.
What to pull together this month
Run an aging report for receivables and payables as they stand. Look for anything over ninety days and decide what you will collect, write off or ask to be reserved. List customer deposits and prepaid items. List every vendor with terms. Pull twelve months of balance sheets and note the seasonal highs and lows.
Then ask your advisors how the structure you are likely to use affects each balance. At Business Advisors of America we build this into the first valuation conversation, so you can see what you are likely to keep, what the buyer is likely to take, and what number you will be asked to leave in the business at closing.
