Starting to think about seeking an acquirer? Prepare in advance by classifying your accounts receivable (AR) with a cold eye to determine what’s collectible, what’s doubtful, and what’s just plain old bad debt. As you begin, note that there’s no shame in having some bad debt. Everyone company has some; it’s unavoidable.
Undertaking this AR review (or more accurately an exercise to score the collectability of your AR) will almost certainly be more intense when prepping for an acquisition than if you were just continuing under private ownership. As a private company that’s not seeking acquisition, your accounts receivable management is likely a little personal. In other words, you likely know the holders of the accounts that are getting close to those 60- or 90-day trigger points. You and your credit manager may have even let someone slide into danger zones of overly dated AR because that customer has always paid eventually, or that you know they are waiting on an escrow release, or that their lot draw-down got delayed, which delayed the bank draw. And why lose a customer over a few days (or a few dozens of days) delay in getting your money?
This entirely changes when you seek to be acquired. Whether the acquirer is backed by private equity, or is a public corporation, or a competitor across town, these acquirers will bring a (potentially uncomfortable) rigor and ruthlessness to examining accounts receivable.
Sophisticated acquirers won’t be sentimental about “XYZ” Construction’s 90-plus day AR bill, just because you happen to play softball or go fishing with XYZ’s owners. Your credit manager can make the case all day long that, “Well, sure, XYZ is consistently 80-plus days out, but they do eventually pay!” Sorry, that’s not going to fly under new ownership.
Let’s say that you have found an acquirer, you’ve signed a letter of intent (LOI), and you are now in exclusivity with that acquirer. Exclusivity means you’ve selected the winning bidder and turned away other suitors. Now you enter “due diligence,” and the acquirer will ask for—among many other reports—an AR report that includes aging. This report will show accrual for bad debt (if you accrue), bad/uncollectible debt, doubtful accounts, and AR that’s aged sub-30, 30-60, 60-90, and 90-plus days.
The acquirer will work with you and your investment banker (the seller’s representative in the sale) to review a Net Working Capital “peg” that shows which accounts receivable will convey to the acquirer when the deal closes. You’ll find that the acquirer will want only the accounts receivable that is mutually deemed collectible. It’s highly unlikely that the acquirer will take overly aged accounts receivable. If they do assume aged accounts receivable that’s deemed potentially collectable, there will be a negotiated allowance of, say, between 90 and 180 days post-close, to see if the accounts receivable actually comes in. If it doesn’t come in, you, the seller, have to buy that debt, dollar for dollar, from the acquirer, which is effectively a reduction of purchase price for that dollar amount.
How should you prepare accounts receivable when going into an acquisition? First, note that the condition of your accounts receivable will be looked upon as a leading indicator of your overall accounting “hygiene.” So, long before seeking acquisition, work with your credit manager to accrue for bad debt, either A) as a percent of your overall sales, or B) by scoring the collectability of accounts receivable, in buckets of 30, 60, 90, and 90-plus. Be realistic. If you suspect or know the debt will never be paid, or is even on the bubble for collectability, write it off. Then, as your investment banker prepares the deal offering document—called a confidential informational memorandum, or CIM—you can confidently state that all the bad debt has been cleaned up, which will be reflected in a line item of the New Working Capital “peg,” a figure that determines how much money will be left in the business at the closing. Believe me, it’s a “very good look” to have this done ahead of time.
