I Watched a $6M Deal Die Over an $80K Working Capital Peg

That's the episode in 5 words. Your panel works, the lights turn on, then an inspector opens it and finds eight things that'll fail. Leavitt does it up to code the first time. Residential, commercial, industrial. Get the loose wire fixed before it costs you the house. Leavitt Electric, Dover, New Hampshire. Find them at leavittelectrical.com. That's brutal. That's ridiculous. $80K out of $6 million is nothing. So how does something so small blow up so big?

I mean, besides the legal impact as well. It really blew up because nobody told the seller it was coming. And that's the core failure of why that happened, right? It's a first-time seller. There's no CPA, no attorney or broker sat down with him and said, after the LOI, there's a working capital adjustment. The number will change. It's not a renegotiation. It's just part of the deal.

It's just another mechanism. So expect it, right? But it felt like an ambush, and ambushing a $6 million deal flips your lizard brain. Now it's like, oh, are you coming after me? Exactly. And so they stopped negotiating and then started defending. And every email was a battle. Every line item was personal. The attorneys made it worse. They're not bad attorneys. They're doing their jobs. They're trying to win the details.

So nobody's incentive was to protect the deal. The deal had no advocate in this case. So $6 million of enterprise value burning in the background while two sets of lawyers argue over accrual timing. Think about that. $350 an hour each, and they're arguing over accrual timing. So your lawyer works for you. Theirs works for them. But nobody in this case was working for the transaction. And the transaction in this thing is worth $6 million, not the short-sighted 80 grand.

Right. Everybody's got representation except for the deal itself. The deal showed up alone. The deal always shows up alone. Let's dig in on something. You said peg and true up. Break those things down. So if you get in these situations where you got something unexpected, ideally what solves this is, you know, somebody being educated around the process, just a little bit better. So you got expectations around it, but break those things down for pegging and truing up because most owners haven't really heard those terms.

So let's educate them, let's help them. So peg is not just for pirates' legs, right? It's the target level of working capital both sides agree on. The normal the business carries, right? So usually it's a trailing 12 month average or sometimes a trailing six. And sometimes it's negotiated depending on circumstances, seasonality, those kind of things. A true up is the adjustment after closing, right? So at close, you estimate working capital off of your most recent numbers, usually the month end before close.

So you close on the estimate, right? So 60 to 90 days later, the buyer's accountants calculate the actual working capital on the exact day of close. Higher the peg, right? Higher than the peg, the buyer sends a check. Lower, the seller sends one back, okay? So here's where it gets ugly. The true up hits after you've cashed the big check. You're mentally done, you're on the beach, you're sipping your pina coladas, right?

And then bam, the phone rings, you owe $120,000, right? Because receivables came in light. That's the call that drops your stomach at 3:17 AM, right? Owners lose their minds over the true up. It's not because the math is wrong, it's because nobody told them it was part of the deal. They think close means close. In M&A, close means mostly close pending a few things that can still cost you six figures, asterisk.

To close, close has an asterisk. Close has a footnote and the footnote has six figures in it. Thanks. Yeah, people need to know that, right? And they need to plan for that. What are the things that usually blow up when going through that process, the working capital negotiation? Where does the fight normally happen? Let's give people more information on that too. So almost every time, Jon, it's in these five places.

One is receivables. The buyer says your 90-day AR is uncollectible. You say they're just slow. It's my cousin Vinnie. He'll get there. But the buyer doesn't care. So they take 15% of AR over 90 days. It's a direct hit to your working capital. Inventory. The buyer walks in the warehouse, calls 20% of your inventory obsolete. But you carried it at full value because nobody wanted to write it down, right?

Maybe it is obsolete, but you just didn't do the mechanism to write it down. So the buyer just took it for you. Accruals and prepays, right? So accrued expenses, prepaid expenses, those kind of things. It's really a nerd fight, right? This is not Fight Club. This is nerd fight with pocket protectors and all kinds of stuff. Right. And so they're saying, you know, did you book the accrual?

Did you amortize the prepaid? You know, in inconsistent bookkeeping, the Q of E will normalize it and the number will move. Okay. Customer deposits, right? Deposits on future work. The buyer calls it a liability because it's not an asset. It's money that is owed on work not performed. And that formula shifts as well, but it surprises the owners every single time because it's in the cash.

Right. And then the owner's payables is a big one. Personal expenses run through the business and it's settled later, right? Later. So the buyer sees real payables owed to you, but because of messy bookkeeping, it just costs you at the closing table. It just costs you a check on the beach. Customer deposits are basically a liability. Isn't that you're collecting money? Is that bad? So you collected money, which is good, but you haven't done the work yet, right?

So the buyer is buying the obligation to perform that work, not the deposit. Gotcha. Okay, so it's got to be an adjustment on that. That's annoyingly fair. Yeah, unfortunately, like I said, both sides can be right and the deal goes to sell. Quick break. And Jon, I want it on the record that I have behaved this episode. Noted, still brought to you by Leavitt Electrical on the Seacoast.

And here's the tie to what Ryan keeps saying about running a mock inspection on your own books. The mock Q of E. Right. You don't wait for the buyer to find the problems? You bring in a pro who finds it first. That's exactly what Leavitt does with the panel. They open it, they tell you what's going to fail, you fix it on your terms, not at the worst possible moment.

And these are credentialed people, licensed in New Hampshire, Maine, and Massachusetts. They've even got the bucket truck. Oh, as a Canadian, I have a deep respect for a man with a bucket truck. I will not be explaining why. That's your one. That's my one. Point that is, the inspection is cheaper than the fire. Leavitt Electric, Dover, New Hampshire, it's all at leavittelectrical.com. Back to it. Generally, now we're talking about $80K in this instance, but generally, how much money are we talking about on a typical deal?

How big is a working capital adjustment? That's a good question. On $5 to $10 million, the adjustment can be 50 to a quarter of a million, right? Sometimes more, and the range is so wide it's because it's really how clean or messy the books are, right? So if you got clean books, you got consistent accruals, your AR is current, there's no personal expenses, it's boring, it's really just a rounding exercise, right? Nobody's going to fight over that. But if you got some messy books, and you got some stale AR, cousin Vinnie hasn't, you know, talked to you for a while, owes you some money, he's good for it, right?

You haven't reconciled your prepaids, you've got some really old obsolete inventory you haven't run off. And plus that nice big truck that you had you flowed through AP, it could be massive, right? And so this is where everybody fights. And it could take weeks. The math nobody does is that a $200,000 dispute doesn't cost you $200,000. It costs you the deal momentum and perhaps it could cost you the deal in this case, right? So and the more you fight, the more legal fees there are, right? So if we're gonna fight for three weeks, both attorneys, that's $30,000, $60,000, you know, $80,000 out there. And so if the deal collapses, you know, you lost $6 million because you couldn't keep your books clean for 18 months previous, right?

So the $200K fight you're fighting for over that table is the direct consequence of a $5K cleanup you skipped two years ago, right? That's the most expensive laziness in M&A. Wow. Yeah, that's 5 grand you could have spent two years ago, with 200 grand on the table and a deal that goes south and you're spending tens and tens of thousands of dollars on legal fees that you're going to be on the hook for regardless whether the deal goes through or not.

That's crazy. Those numbers don't really add up. Well, they're really the same number, Jon, but that $5K grew up to be $20K, $40K, $100,000. Yeah. Wow. That's crazy. I think a lot of this ties back to what we had in a previous episode. I can't remember which one. Good books for clean books versus good books. Stellar episode. Bookkeeping, that way high on the list of most boring subject matter that we talk about, but essential in this case. This is the word consequence of having good clean books. Yeah, you're absolutely right, and so, like we talked about, the spider web, everything's connected, right?

We're connecting back to an episode of the importance of having clean books versus good books, right? And this is exactly that consequence right here, right? Your books can be accurate and still useless, right? So here's the useless part costing someone a deal, right? Books are reconciled, CPA filed, clean returns, everything added up, but it's built for tax compliance, not due diligence, right? You got instance inconsistent accruals, prepaids not amortized, AR aging is not managed, inventory at values nobody had validated in two years, right? This is what happens when you give your CPA your numbers at March 15th for an April 15th deadline, right? They don't have time to look into this stuff. But it mattered for the tax return, but it doesn't matter for the data, right? The Q of E team, in this case, found every inconsistency and used each one to adjust working capital downward, right, because they're working for the buyer, right.

It was legally, it was legal, it was correct, but it was also devastating. So if you restructure 24 months out, right, and you do the $5K cleanup and you keep it clean, right, you tighten your accruals, you clean your AR, you write down stale inventory, you separate your personal, right. The adjustment will turn into $15,000 then, not $80,000 when you're going to sell. Nobody's going to fight over $15,000, right?

The deal's going to close. The seller's going to get their $6 million, right? And it's going to be reflected on a tax return. There's nothing to worry about. Clean data is what will move the needle, right? But if you skip it, that's where you pay at the exit, at the closing table, right? So every dollar of messiness is a dollar a buyer's attorney will find and use against you, and they will because literally that is their job.

And they get paid for it regardless. So yeah, it's in their best interest to find these things and negotiate the heck out of them. Or to fight for three weeks over $80,000. Let's talk about how much we love M&A and lawyers. That's another episode. That is an episode. There's some great ones out there and we work with some great people. So that is not negating any of those great people but there are some out there that are always interesting.

Basically what we're saying is the books were clean but that wasn't enough. It's clean for the IRS, Jon, but the buyer isn't the IRS. The buyer is worse and the buyer is going to read everything. Right, okay, now we're getting into the segment. We do this every week. What should people actually be looking for? What can they do to prepare for it? So if somebody is two to three years from selling, and you have said this over and over and over again, prepare now, prepare now because it causes your organization to run better.

But if somebody is, you know, those number of years out, what should they be doing to prepare for it now? So five words, do it before, not during. Okay, so there's five moves that you can make. Everyone can be done between 18 and 24 months before you go to market, right? Don't do it during the deal, before. One, make your books audit-ready. Consistent accruals, clean prepaids, properly aged AR, inventory at real value, right?

If your bookkeeper can't do this, hire somebody who can, a fractional controller or a fractional CFO who has a good accounting background, right? Get somebody in there to do it. It's gonna be worth the thousands of dollars later. Two, know your own working capital number. That's right, folks, we're here, we give you homework, right? You should know your trailing 12 month average. If you don't know it, you're gonna have zero leverage when the buyer proposes their peg, right?

Because you're just gonna react to their math. We always do the calculation, no matter what side we're on, so that we can defend it, right? Three, clean up AR. That's right, collect everything over 60 days. This is just good cash flow management, going back to our Profit First episode, right? Oh my God, there's another web that's formulating, Jon. Right, and then write off anything that's over 120 days that's generally dead.

And you know, you're better off taking the hit on your terms than at the closing table. And one other thing is that if you're consistently writing off things over 120 days, you need to revisit your collections process. That's a little bonus tip. Four, run a mock Q of E. Hire an independent firm to do a Q of E on your books first, find the problems and then fix them.

It's gonna cost you some money, but you're gonna know exactly where to start looking and guess what, it's gonna be better business for you as well. So every issue you find and fix is the one that the buyer's team can't use to adjust your price. $6 million became $6 million again. $420,000 working capital peg became $420,000 working capital peg. And then five, this one is that getting an M&A experienced advisor before the LOI, right? Not a business broker, right? Someone who has lived working capital negotiations and can tell you what's normal, what's aggressive, when to push and when to let it go. And there are people out there who do that, right? So the absence of that person killed the $6 million deal, right? Nobody knew when to say, this is an $80K dispute on a $6 million deal, split it and close.

All right. We always give people homework and the previous episode on the buy box was, hey, run a mock buy box on yourself. The audit when you're the bottleneck, right? Like you, there are things that you can do. Find the time and run these processes on yourself. The homework's important because it's really going to prep you. And a word from our sponsor. This one is the punchline of the whole episode.

Which is? We spent this episode saying, do not bring a real estate attorney to an M&A knife fight. Same energy. Do not hand your electrical panel to your brother-in-law with a YouTube tab open. Call back to last episode. That is roughly what our seller did with his deal team. Get the pro who's done it 10,000 times. The Leavitt crew has been wiring the Seacoast for over 20 years. Homes, offices, full commercial builds, the works. The licensed person who has done it a thousand times is the entire thesis of the show. That is right. So leave it to the people whose job it is or as they say, when it comes to electrical, leave it to Leavitt.

Leavitt Electrical, Dover, New Hampshire, find them at leavittelectrical.com. Right tool, right room, right pro. Don't bring the butter knife. On that point there, the deal representing itself, somebody needs to protect it, and this isn't just the client. How does an owner make sure that happens? Well, you need someone at the table whose job is to get the deal done, not to win every point, right? Their attorney protects you, their attorney protects them, both are doing their jobs when they fight, right?

But the deal has no lawyer, the deal needs an advocate, right? That's the transaction advisor, the deal quarterback, sometimes the banker, right? The person who says, this issue is worth $40K, we spent $35,000 arguing it. This is now negative ROI. Split it and let's move on, right? On the deal that died, that person didn't exist. The seller had a local attorney who had done real estate closings, never an M&A dealing.

The buyer had a sharp M&A firm running circles around the seller. A knife fight was brought where one side brought a butter knife and the other one brought a Rambo knife. It was not even a fair fight at the beginning. It wasn't about the money, it wasn't about the business, and it wasn't the buyer's intent. The wrong team for the transaction was there. By the time the seller saw it, the trust was gone and the deal was dead. The team that runs your business, and I have to say this, is that it's not the team that sells your business. One gets it ready and one gets the transaction done. Your CPA files your taxes, your local attorney handles your contract, but neither have done a working capital negotiation, so you got to get the people who have before the LOI and not just after the first fight, right, and they can work with your folks to

get, make sure that it's all done. Yeah, it's a representation of all sides where the temperature is reduced as well, like you're going through one at the moment and there's a lot of temperature reduction needed in certain aspects. I know we can't share details or anything, but because you're so in the loop with all the components of the deal, you're able to bring all sides of the table and just work through these things. So it's an important distinction there. You're representing the deal itself in that instance.

Right. You're absolutely right. So if an owner's listening hasn't sold a business before, what's the one thing they should take away from this before we get to our official takeaway for the episode? The headline number is not the final number, it never is. $6 million is the starting point of the negotiation and then you have working capital adjustments, escrow holdbacks, earnouts, a dozen mechanisms that shift the risk from buyer to seller.

None of it is in bad faith, it's just how deals work. But if nobody explains it, it feels like bad faith and that feeling kills transactions. That's that lizard brain that comes back up, right? So you got to know the mechanisms and what they are before you sign the LOI. Working capital, how the peg is set, the true up, the escrow terms, right? You don't need to know this on an expert level, just enough that nothing will surprise you when you get that call on the beach, right?

Receivables were light, and you have that, are ready to go in M&A, and like everything in life, surprises, the enemy of a close. Remember, buyers like predictability, so do sellers, right? And please, don't let an $80,000 dispute kill your $6 million outcome. That seller didn't lose $80,000. He lost $6 million, right? Because nobody had the perspective to say this is 1.3% of the deal. Take a breath, sign the paper, go live your life. That sentence was worth $6 million and nobody said it. Don't be that seller. That's crazy. Know the mechanisms, build a team, clean the books. That's the whole show. That's the whole show. And it came down to that one sentence that nobody said. Eight seconds, $6 million, say the sentence. Alrighty, so the takeaway, let's do it. What's the takeaway from this episode?

Alright folks, the headline number is never the final number, that's just the beginning. Working capital adjustments, escrow holdbacks, and true ups aren't bad faith, they're how deals work. But if nobody explains the mechanisms before you sign the LOI, every adjustment feels like a betrayal and betrayal kills deals faster than bad numbers ever could. The $5K and bookkeeping cleanup you will skip today and becomes the $200,000 dispute that stalls your deal tomorrow.

Clean your books, know your working capital number, run a mock Q of E and put someone at the table whose only job is to protect the transaction. One sentence. This is 1.3% of the deal. Sign the paper. Go live your life. It was worth $6 million and nobody said it. Don't be that seller. That is a wrap. Thanks, Ryan. Great episode. We will see everybody next week. Hasta luego.

That'll do it for this episode of From Burnt Out to Bought Out. If anything we talked about today hit home, do us a favor. Share this episode with another owner who needs to hear it. And if you're sitting there thinking, they're talking about me, good. That's the first step. Head to the show notes and book a free triage call with our team. No pitch, no pressure, just a real conversation about where you are and what's possible. You can also find us on LinkedIn and at wearesynergysolutions.com. New episodes drop every week. Until next time, stop running the treadmill and start building something you can actually sell.