Working Capital in Urgent Care M&A Transactions
When negotiating the sale of an urgent care center (UCC), it’s important to look at the center’s working capital.
“Working capital is essentially current assets minus current liabilities,” Bill Horton, Healthcare and Business Lawyer at Jones Walker LLP, says. “In practical terms, it includes how much cash you have and how many things you have that can be turned into cash relative to your current obligations. It’s the amount of money needed to run your businesses on a day-to-day basis.”
Todd Zigrang, President of Health Capital Consultants, says that cash and accounts receivable are key components of working capital.
“Accounts receivable can certainly amount to 30 to 45 days of revenue or more,” Zigrang says. “Cash flow management strategy is to shorten the number of days in accounts receivable so that it may be converted to cash to fund operations.”
Accounts receivable play a large role in the valuation process of an urgent care center. Sellers and buyers will frequently disagree over how much the accounts receivable are worth.
“The older the accounts receivable are, the less likely they are to be collected,” Horton says. “The seller will often have his or her accounts receivable valued at a level greater than what the buyer thinks they are worth, and sometimes the seller hasn’t been as aggressive as they should have been with writing off the accounts receivable.”
“When you have claims that are 90 or more days old, there’s typically some kind of problem,” Zigrang says. “Accounts receivable that old may be a risky asset.”
In order to avoid a dispute over accounts receivable, some buyers and sellers will negotiate a cash-free and/or debt-free transaction.
“Often in transactions involving urgent care centers, the seller will retain the cash, the accounts receivable and all of the risks related to those assets,” Zigrang says.
“If you take accounts receivable out of the deal all together and leave them in the hands of the seller to collect, then you eliminate any arguments over what they’re worth,” Horton says.
Curtis Bernstein, Managing Director of Valuation Services for Altegra Health, says that a debt-free transaction is also a way to avoid disputes.
“In a debt-free transaction, the buyer doesn’t assume any of the debt of the seller,” Bernstein says.
Zigrang says that buyers prefer debt-free transactions.
“It’s more preferable to acquire an enterprise free and clear of debt,” Zigrang says. “You don’t want to buy someone else’s problem.”
Horton says that the best thing to do when negotiating a deal that includes working capital is to clearly define how working capital is going to be calculated and how different components will be valued.
“Have these arguments up front; it becomes hard when it gets to closing time if the seller has already mentally spent the money they are expecting to get, and the buyer has mentally started to think of all of the accounts receivable that they’re going to get, and those numbers end up changing,” Horton says.
The amount of working capital a center has can affect how the transaction is carried out. Horton says that post-transaction settlements usually occur 60-90 days after the closing.
“The buyer will come in and do a calculation of what the actual working capital was on the day of closing,” Horton says. “If that is different than what the parties assumed would be the case, then either the buyer will have to pay the seller more money, or the seller will owe the buyer money. Anytime that you have the prospect of one party having to pay money to the other after closing, you can expect that there will be some irritated feelings.”
In order to avoid frustrating adjustments, Horton says that parties can negotiate that there will be no exchange of money after closing, but that depends on the bargaining power of the parties.
“One thing you can do to mitigate disputes over capital adjustments is to negotiate out an escrow of a portion of the purchase price,” Horton says. A certain percent of the purchase price is held back after purchase, and then after the working capital position is solved, it is either released back to the buyer or goes to the seller. “This is a good idea because sometimes if the buyer has to go get money back from the seller that the seller has already gotten in hand, the seller isn’t always going to want to give that money back,” Horton says.
Urgent care centers will either have not enough, just enough, or too much working capital to operate, according to Bernstein. Zigrang explains the current ratio formula is used to determine if there is excess working capital, or not enough capital.
“The current ratio formula is current assets divided by current liabilities,” Zigrang says. “Given the facts and circumstances, accounts receivable – which typically is the largest component of a UCC’s current assets – should be adjusted to the Fair Market Value of their collectable amounts. You want to make sure that the ratio conforms to industry benchmarks, which may be in the range of 1.5 for urgent care centers. Anything under 1.0 is considered problematic, since the business has more debt coming due in the next 12 months than assets that can be converted into cash.”
Zigrang says that buyers and sellers will look at the industry benchmark for working capital for urgent care centers. If the ratio is excessively higher than the industry benchmark levels, then the center could have excess working capital.
“If this happens, the excess working capital may be treated as a non-operating asset,” Zigrang says. “But that doesn’t mean that it doesn’t have value. It could be utilized for other purposes.”
Horton recommends consulting a professional during the negotiation process, especially if a buyer or seller has never done this type of transaction before.
“If you have help from someone that has experience in this area, they can help you anticipate problems and keep the transaction going smoothly,” Horton says. “At the end of the day, you’re likely to end up with a better deal and more money in your pocket.”
Horton also mentions that it’s helpful for sellers of an urgent care center to consult a professional advisor in order to have an objective third party as part of the transaction.
“If you’re a seller who has built-up a business and is now looking to cash in, that’s an emotional process. You’re taking your life’s work, and selling it to someone else,” Horton says. “It becomes hard to see things clearly and objectively. If you have a professional advisor, they can be your voice of reason.”
Working capital is one of the most important factors buyers and sellers of urgent care centers need to pay attention to during a transaction.
“Working capital is vital to most businesses, including UCCs,” Zigrang says. “Insufficient cash flow is why a significant number of businesses fail. You must have enough working capital to maintain operations and pay off the expenditures as you grow your business.”
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