I Watched a $6M Deal Die Over $80K

Okay. It's a $6 million service of business. Good revenue, clean margins, volatile handshake at 6 million.

The LOI is signed. The seller told his wife champagne was almost in the cart. Then the lawyers start the purchase agreement around page 47, the working capital adjustment.

And that's where the deal started bleeding three weeks later. It was dead. Not the business, not the price, but two sets of attorneys, 21 days fighting over 80 K 80 K on $6 million is 1.3%. That is what killed it.

The seller thought that the buyer was acting in bad faith. The buyer thought the seller was hiding something, but neither was true. The real cause, nobody explained the mechanism before the LOI.

So it felt like a bait and switch. It wasn't a bait and switch. This is just M and a insane, insane tiny percentage of overall revenue.

But let's back up a little bit. For everybody listening, who's never bought or sold a business, what's a working capital adjustment? Why does it exist? So I'm really glad that you say that they're on is a, it's, it's kind of like the simplest version I can say is that the buyer is buying a running machine and it needs fuel in the tank on day one. That fuel is working capital, cash receivables, inventory, right? And you have some payables and they're, you know, essentially cash receivables, inventory minus what you owe, right? The buyer isn't paying $6 million than funding two months of payroll out of pocket, right? You're selling a business, not an empty building.

Both sides agree on a target, which is called the peg, the normal expected level of working capital. So if a business carries $400,000 in net working capital, the peg is $400,000. Okay.

At close, if it's above the peg, the buyer pays you the difference. If it's below it, you owe them dollar for dollar. Sounds simple.

It is not. It's what counts and how you calculate it is where deals go to die. So basically I can't just sell you the business, keep the cash in the drawer and put it in my pocket, right? You can try.

The buyer will notice the drawer is empty on day one, right? And it gives them nothing. They have to immediately inject cash, which is why we have the working capital adjustment. Got it.

Understand. So what went wrong with this one? Where did the ADK gap come from? So in this deal, the peg was set at $420,000. Both sides agreed at it at the LOI, their handshakes, then the buyer's Q of E firm, right? Quality of earnings, the same crew from the buy box episode that we did previously, they excluded stale receivables.

They reclassified a prepaid expense. They fixed an accrual. The bookkeeper hadn't booked inconsistently for two years.

The seller pushed back on every single adjustment and the buyer held firm. Each side was technically defensible. That's the nightmare.

Both are right. And the gap was $80,000. The seller heard, you agreed to $6 million.

Why are you nickel and diming me? The buyer heard the working capital you promised isn't there. We're not paying for an empty building. We're not paying for air.

Both are very reasonable. Neither could see the other side, but the deal didn't die over the money. It died over email.

Right. That's ridiculous. And it's often the case when legal representatives get very heavily involved.

It seems like both sides are right, but it was a bad outcome. Yeah. Welcome to deals, right? Two right answers, 80 grand apart and nobody blinks.

Quick break. A fitting one, given that we just watched 80 grand burn a $6 million deal to the ground. Here it comes.

This episode is brought to you by Leavitt Electric out of Dover on the New Hampshire Seacoast. 20 plus years keeping the lights on for homes and businesses up and down the coast. And they fit this episode perfectly because everything we just described is electric.

Go on. The 80 grand was a loose connection. Nobody inspected.

It sat behind the wall for two years. Then the deal got into the data room. Somebody opened the panel and it sparked.

Wow. I like it. So the whole episode is the difference between it works and it's up to code.

That's the episode of five words. Your panel works, the lights turn on, then the 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 you cost 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 the first time seller.

There's no CPA, no attorney. Our broker sat down with him and said, after the NLI, 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, an ambush in a $6 million deal flips your lizard brain.

Right? Like 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. You know, they're not bad attorneys.

They're doing their jobs. They're trying to win the details. Right.

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, argue over accrual timing.

Think about that. $350 an hour each and they're, they're arguing over accrual timing. Right.

So, you know, your lawyer works for you, theirs works for them, but nobody in this case was working for their transaction and the transaction. And this thing is worth $6 million, not the short side of 80 grand. Right.

Right. Everybody's got representation except for the deal itself. The deal showed up alone.

The deal always shows up alone. That's digging on something you said, peg and true up, break those things down. So if, 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've got expectations around it, but break those things down for pegging and truing up because most, 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, 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 kinds 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 buyers 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 cash 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 and a close means mostly close pending a few things can still cost you six figures asterisk to close. Close has an asterisk close has a footnote and the footnote has six figures in X. 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, where's the fight normally happen? Let's, let's give people more information on that too. So almost every time, John, it's, it's in these five places.

One is receivables, right? The buyer says your 90 day AR is uncollectible. You say they're just slow. It's my cousin Vinny.

He'll get there. Right. But the buyer doesn't care.

So they take 15% of AR over 90 days in a, you know, it's a direct hit to your working capital, right? Inventory. The buyer walks in the warehouse, calls 20% of your inventory obsolete, but you carry that full value because nobody wanted to write 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 prepaids, right? So accrued expenses, prepaid expenses, those kinds of things. It's a really a nerd fight, right? This is not fight club. This is nerd fight with pocket protectors and, 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 and it, 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 their 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're collecting 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 gotta 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 John, I want it on the record that I have behaved this episode.

Noted. Still brought to you by Levitt Electrical on the seacoast. And here's the title of 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 Levitt 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. Levitt Electric, Dover, New Hampshire.

It's all at levittelectrical.com. Back to it. Generally. Now we're talking about 80 K 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.

Um, on five to 10 million, uh, the adjustment can be 50 to a quarter of a million, right? Sometimes more. And the range is so wide it's because really how clean or messy the books are. Right.

So if you got clean books, you 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 get some messy books and you got some stale AR cousin Vinny hasn't, you know, talked to you for a while. I'll always use some money and he's good for it.

Right. You haven't reconciled your, 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 going to fight for three weeks, both attorneys, that's 30, 60, 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 200 K fight you're fighting for over that table is the direct consequence of a five K cleanup.

You skipped two years ago. Right. That's the most expensive laziness in MNA.

Wow. Yeah. That's five grand.

You could have spent two years ago with 200 grand on the table and a dealer 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 of whether the deal goes through or not. That's crazy. Those numbers don't really add up.

Well, they're really the same number, John, but that five K grew up to be 20, 40, a hundred thousand. Yeah. Wow.

That's crazy. I think a lot of this ties back to what we had in the previous episode. I can't remember which one.

Good books for clean books versus good books. Another 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 world consequence of, of having good clean books. Yeah, you're absolutely right.

Like and so like we talked about the spiderweb, 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, 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, amortized AR aging is not managed inventories at values. Nobody had validated in two years, right? This is what happens when you give you 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 V 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 would have turned into $15,000 then not $80,000.

When you're going to sell, nobody's going to fight over $15,000, right? The deal is going to close. The seller is 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? And, 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 of 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, 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 today. There's some great ones out there.

And we work with some great people. So that is not negating any, 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, John, but the buyer isn't the IRS, right? 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, what should people actually be looking for? What can they do to prepare for it? So if somebody is two to three, 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, better. But if somebody's, 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 going to be worth the thousands of dollars later to 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 going to have zero leverage when the buyer proposes their peg, right? Because you're just going to 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 a R that's right. Collect everything over 60 days.

This is just good cashflow management. Going back to our profit first episode, right? Oh my God. There's another web that's, that's formulating John, 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 it is at the closing tables. 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 step. Four, run a mock Q of E, hire an independent firm to do a Q of E earnings on your, your books. First, find the problems and then fix them, right? It's going to cost you some money, but you're going to know exactly where to start looking.

And guess what? It's going to be better business for you as well. Right? 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, right? And then five, this is one, is that getting an MNA experienced advisor before the LOI, right? Not a business broker, right? Someone who has lived working capital negotiations and 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 80 K dispute on a $6 million deal, split it and close, right? We always give people homework and previous episode on the buy box was, Hey, run a mock buy box on yourself. The audit, when you're the bottleneck, right? Like there are things that you can do, find the time and run these processes on, on, uh, on yourself. The homework is 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 MNA 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? Your attorney protects you. Their attorney protects them.

Both are doing their jobs when, when they fight. Right? But the deal has no lawyer. The deal needs an advocate, right? That's the transaction advisor, the deal quarterback, somebody, sometimes the banker, right? The person who says this issue is worth 40 K. We spent $35,000 arguing it.

This is now negative ROI, split it and let's move on. Right? In the deal that died, that person didn't exist. The seller had a local attorney who had done real estate closings, never an M and a dealing.

The buyer had a sharp M and a firm running circles around the seller, right? A knife fight was brought where one side brought a butter knife, right? And the other one brought Rambo's knife, right? There was not even a fair fight at the beginning. And it wasn't about the money. It wasn't about the business and it wasn't the buyer's intent, but the wrong team for the transaction was there.

By the time the seller saw it, the trust was gone and the deal was dead, right? The team that runs your business. And I have to say this is that it's not the team that sells your business, right? One gets it ready and one gets the transaction done. Your CPA files, your taxes, your local attorney handles your contract, but neither of them have done a working capital negotiation.

So you've 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. And 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 where you don't, 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, our, uh, our official takeaway for the episode? The headline number is not the final number.

It never is. Right. $6 million is a 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, right? None of it is bad is in bad faith. It's just how deals work. But if nobody explains it, it feels like bad faith.

And in that feeling kills transactions. That's that lizard brain thing. It comes back up, right? So you got to know the neck and 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? And that receivables were light and you have that are ready to go in M and 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? All right, 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 L line, 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 QAV 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 was worth $6 million and nobody said it. Don't be that dollar.

That is a wrap. Thanks Ryan. Great episode.

We will see everybody next week. 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 we are synergy solutions.com new episodes drop every week until next time. Stop running the treadmill and start building something you can actually sell.