Last Updated on March 14, 2023
Selling a company isn’t a straightforward task. It involves making a lot of deals and finalizing several things. Luckily, you can structure the sale to suit your position.
The calculation of a business’s purchase price incorporates different aspects. Contrary to what some sellers propagate, the value of assets isn’t solely responsible for the purchase price. Financial performance plays a key role in determining this price.
A vital issue you must address is how to handle accounts receivable. Do you retain the accounts or pass them right away to the buyer? It’s important to know the consequences of each scenario before accepting an offer.
What Is Accounts Receivable?
Accounts receivable represent credit sales that customers are yet to settle. Credit sales are a common practice in modern businesses. These sales generally convert to cash between 30-60 days. Receivables that go past one year decrease in value and are unlikely to convert into cash.
How to Handle Receivables During a Business Sale
When selling your business, you can choose to pass or retain accounts receivable. Both scenarios have their pros and cons.
Passing Accounts Receivables
In business acquisitions, some buyers prefer to purchase the working capital of your business. This involves acquiring your accounts.
It’s a risky process that involves the buyer acquiring your outstanding business invoices. The buyer is unlikely to get compensation on very old invoices.
Acquiring accounts receivables is ideal for buyers who:
- Want to deal with customers from the go
- Want to retain cash flows to the business
- Want immediate control over receivables
As a seller, passing account receivables is the best option if you want to effectively cut ties with the business. This move might reduce your profits.
Keeping Accounts Receivable
It isn’t unusual for businesses to retain receivables and payables during a sale. Some buyers prefer unencumbered portfolios. In such cases, sellers have no option other than to resolve their accounts.
It’s possible that certain buyers may be unwilling to spend much effort on collecting receivables. Such buyers are unlikely to acquire receivables.
Size of Your Business Matters
The size of your business will likely influence whether you retain or pass accounts receivables.
Small business sellers tend to hold on to accounts receivables. Such sellers have to settle receivables before selling their ventures. The buyer acquires a fresh business without any attachments.
The opposite applies to big businesses. Buyers interested in large companies require working capital. Accounts receivable provide positive cash flow for such buyers.
Exclusion of Accounts Receivables in Small Business Sales
Business sales that involve small ventures exclude cash and receivables due to several reasons.
The primary reason is to provide a new start to the buyer. The seller facilitates this approach by handling liabilities and any current short-term assets.
Other reasons include:
- Lower returns for the buyer
- Inflation of the multiple
You can save taxes on sales by keeping accounts receivables. When you maintain receivables, you only pay taxes after receiving income. You also enjoy write-offs for collectible payments.
When the buyer acquires accounts receivables, you file the amount as income after-sales.
It’s always advisable to consult a tax expert before retaining or passing your account receivables.
An asset sale occurs when a business sells its tangible and intangible assets. In most of these sales, buyers prefer getting a debt-free company. If you keep accounts receivable, you’re likely to attract a suitable buyer.
Type of Business
Service ventures rely heavily on repeat clients. When the buyer acquires receivables, they take a risk. As a seller, you have to factor in this risk when receiving payments on uncollectible accounts. You’ll receive lesser amounts once the buyer deducts the risk percentage.
What If Factoring Is Involved?
Invoice factoring could work in or against your favor during a business sale. In factoring, a funding source acquires your business’s accounts receivables. You sell your invoice’s face value at some discount. It works as a loan that accelerates your business’s cash flow.
Factoring is a major issue in business acquisition. You have to inform prospective business buyers whether a third-party agency, or factoring company, controls your account receivables. The buyer might retain the third-party services or adopt a different model.
There are several ways of handling factors before selling a business.
The first option is to end the factoring contract several months before selling your company. This option requires a well-thought plan and might be problematic if you are contractually bound. Your business can also encounter major cash flow hurdles when the funding source is cut. Cash flow issues might put off some buyers or lower the purchasing price.
The second option is retaining the factor’s services during the selling period. In this scenario, the factor is solely responsible for any outstanding receivables during the transition period. This option works well if you intend to retain cash and accounts receivables. It ensures you’re selling a debt-free business.
If the buyer finds your funding model appealing, they might retain the funding firm. In this case, the buyer retains the same contractual relationship with the factor. The seller won’t be responsible for accounts receivables. This option is highly dependent on the policies and terms of the factoring firm.
Another option involves the buyer contracting the factor after the sale. In this scenario, the factoring company enters into a new contract to handle the business’s invoices. The previous contractual relationship between the factor and the seller ends once the sale is made.
What’s the Norm?
Most buyers don’t take accounts receivable. Instead, they come with ample working capital. You’ll have to offer them a debt-free company for them to finalize the deal. This translates to retaining accounts receivables and paying off payables.
Only large firms acquire balance sheet items to generate instant working capital. Sellers of such firms must forfeit ownership of accounts receivable.
Two things happen to your accounts receivables when you sell your company. You either retain or pass the receivables to the buyer. The choice of whether to keep or to let go depends on various factors. Since most buyers prefer a clean and free business, you are likely to retain account receivables when selling your business.
Jim is the General Manager of altLINE by The Southern Bank. altLINE partners with lenders nationwide to provide invoice factoring and accounts receivable financing to their small and medium-sized business customers. altLINE is a direct bank lender and a division of The Southern Bank Company, a community bank originally founded in 1936.