Navigating the Complexity of the Net Working Capital

Navigating the Complexity of the Net Working Capital

In the world of mergers and acquisitions (M&A), there are multiple terms and process dynamics that come into play over the course of a transaction. One term that often stands out from the rest due to its complexity is net working capital. While it may seem like just another financial metric, the net working capital in the context of M&A transactions can have potential implications on the overall purchase price of a transaction. The purpose of this post is to provide founders with insight into net working capital, its role in a M&A transaction, and how to effectively prepare for the net working capital adjustment negotiation.

What is Net Working Capital?

Net working capital is definitionally defined as current assets minus current liabilities, but the metric takes a different form in an M&A transaction. Through the lens of a transaction, net working capital is often defined as current assets (excluding cash and cash equivalents) minus current liabilities (excluding short-term debt and debt-like items). The financial metric is utilized to assess the financial health of a business – it is a measure of the company’s ability to satisfy short-term liabilities and operational liquidity. Furthermore, an ideal position for a business is to have positive net working capital.

What is the Net Working Capital Purchase Price Adjustment?

The net working capital purchase price adjustment is often an unfamiliar term to founders prior to embarking on an M&A transaction. When a buyer submits an LOI, the terms will often include that the purchase price assumes the business will be acquired with sufficient levels of net working capital. Said differently, the purchase price implicitly included the value of the company’s net working capital. Buyers include this term to protect against the potential situation where a seller liquidates their current assets from the business and delays satisfying their current liabilities until the transaction is complete – leaving the buyer with a less valuable business. As you may be wondering, how is a sufficient level of net working capital determined and what are the mechanics for the adjustment? During the due diligence phase, buyers dive deep into the components of net working capital, analyzing trends, assessing liquidity ratios, and evaluating historical net working capital cycles. Following their analyses, the buyer will propose what they view as the sufficient level of net working capital, often called the net working capital peg. There are multiple different methods used to calculate a net working capital peg, but a typical approach buyers will take is to present the peg as the average of the last twelve months (“LTM”) net working capital. Please see below an illustrative example of a LTM peg calculation:

The net working capital peg is typically a focal point of negotiation as buyer and seller strive to reach a consensus that is a “win-win” for both parties as the adjustment isn’t traditionally thought of as a mechanism to increase or decrease value. The net working capital adjustment is the difference in the company’s net working capital as of the closing date of the transaction vs. the net working capital peg amount. For example, if the closing net working capital amount is higher (lower) than the net working capital peg, there would be an increase (decrease) to the purchase price. Please see below an illustrative example of how the net working capital adjustment works in practice:

How to Effectively Prepare for Net Working Capital Negotiations to Optimize Value

Rigorous, proactive preparation and strategic planning for net working capital negotiations is critical to ensure maximum negotiating leverage is achieved to arrive at the optimal net working capital peg. Prior to net working capital negotiations, sellers and/or their investment bankers should undergo detailed analyses to understand the historical trends of each balance account to: 1) identify any anomalies that skew historic net working capital trends, 2) understand the cycles of each account (i.e. is there seasonality?), and 3) have thorough analyses to underpin their view of the optimal net working capital peg. Being on the “front foot” with robust and accurate analyses to support your negotiation position and understanding how the buyer might counter enhance your negotiation strategy, mitigate risks, and maximize the potential for a desired outcome.


As founders begin on the M&A journey, understanding the nuances of net working capital and the adjustment becomes paramount. The adjustment underscores the importance of effective due diligence and preparation, sound advice from an investment banker regarding market standards, and tactical negotiation strategy. Mastering the art of successfully navigating the net working capital adjustment is crucial to preserve overall transaction consideration and ensure both parties view the result as a “win-win” ahead of creating a long-term partnership. If you would like to learn more about the net working capital adjustment or the M&A process, please feel free to contact me at [email protected].

Understanding the Transition: From Non-Recurring to Recurring Revenue Models in Boutique Professional Service Firms

Understanding the Transition: From Non-Recurring to Recurring Revenue Models in Boutique Professional Service Firms

Understanding the Challenge

For founders of boutique professional service firms, the shift from a non-recurring revenue model to a recurring revenue model is often a strategic move towards long-term stability and growth. However, this transition can be challenging, especially in terms of cash flow management. This article aims to guide you through this complex yet rewarding journey.

The J Curve: A Critical Concept

Before delving into the specifics, it’s essential to understand the concept of the J Curve in the context of this transition. The J Curve is a visual representation of a company’s cash flow following a significant investment or change in business strategy – initially, there’s a significant outflow of cash (the bottom of the ‘J’), but with time and effective management, the curve ascends, leading to increased profitability.

How the J Curve Applies

When switching to a recurring revenue model, your firm initially faces increased costs without immediate returns. These costs include client acquisition, setting up systems for recurring billing, and potentially, a temporary dip in revenues as you transition existing clients or onboard new ones. This initial phase represents the bottom of the J Curve.

Calculating Break-Even for a Given Client

To navigate this period, a clear understanding of the break-even point for each client is crucial. Here’s how to calculate it:

    1. Cost to Acquire (CTA): This includes marketing expenses, sales team costs, and any other costs directly related to acquiring a new client.
    2. Cost to Serve (CTS): These are the ongoing costs of servicing a client, including labor, software, or other resources.
    3. Overhead Allocation: Allocate a portion of your firm’s overhead costs to each client, based on a reasonable metric like revenue contribution or service hours.

Break-Even Point Calculation

Your break-even point is when your cumulative revenues from a client equal the sum of CTA, CTS, and allocated overhead.

The Exponential Profit Beyond Break-Even

Once the break-even point is met, each additional dollar from the client significantly contributes to your firm’s profitability. This exponential increase is due to the recurring nature of the revenue and the decreasing marginal cost of serving a client over time.

The number one reason boutique professional service firms do not make the transition to recurring revenues is they cannot handle the cash crunch. Firms get used to big checks hitting the bank account in a traditional project-based billing cycle. It is difficult to tell a client not to pay them so much this quick but rather pay them over time pro rata over the life of the contract. The founder sees the payroll going out without the revenue coming in and the cash balance in the bank account dwindle month over month, panics, and says “recurring revenue is not for us.” This is a mistake and there are solutions to the cash flow issues.

Overcoming Cash Flow Obstacles

Short-Term Solutions

    • Leverage Credit Facilities: A short-term loan or line of credit can help manage cash flow during the initial phase.
    • Re-negotiate Payment Terms: With suppliers or landlords, for instance, to align outflows with your new revenue model.

Long-Term Strategies

    • Optimize Client Acquisition Costs: Use data-driven marketing and sales strategies to reduce CTA.
    • Efficiency in Service Delivery: Streamline processes to lower CTS.
    • Client Retention: Implement strategies to retain clients, as the longer a client stays, the more profitable they become.


Transitioning to a recurring revenue model in a boutique professional service firm is a strategic move towards sustainable growth. Understanding and managing the J Curve, accurately calculating the break-even point, and implementing strategies to mitigate cash flow challenges are key to successfully navigating this transition. With careful planning and execution, the move to a recurring revenue model can lead to increased stability and profitability for your firm.

Are you wondering how to transition to recurring revenue? Or how to address the cash flow issues associated with the move? These strategic questions, as well as many others, get answered by your peers in the Collective 54 mastermind community. Consider joining by applying here

Episode 56: Cash Flow: Where to Find Working Capital to Scale – Member Case with William Lieberman

C54 member William Lieberman, Managing Partner of The CEO’s Right Hand, shares insights on cash flow and where to find working capital to scale your professional services firm.


Sean Magennis [00:00:15] Welcome to the Boutique with Collective 54, a podcast for founders and leaders of boutique professional services firms. Our goal with this show is to help you grow, scale and exit your firm bigger and faster. I’m Sean Magennis, Collective 54 Advisory Board Member, and your host. On this episode, I will make the case that boutiques run on cash flow. They do not run on net income or EBITDA. I’ll try to prove this theory by interviewing William Lieberman, managing partner of the CEO’s right hand. William provides outsourced financial CFO and accounting services to clients that are growing or scaling. They offer end to end solutions for ongoing or one time project needs that span a broad spectrum of industries, including finance, technology, e-commerce, investment banking and digital advertising strategy. You can find William at William, great to see you and welcome. 

William Lieberman [00:01:29] Thanks, Sean, it’s great to be here. 

Sean Magennis [00:01:31] Excellent. So let’s get started, I’d like you to do an overview. Can you briefly share with the audience an example of why cash flow is so critical to scaling a boutique? 

William Lieberman [00:01:43] Absolutely. You know, everyone’s heard the old adage. Cash is king, right? Cash flow is the fuel of your business. And without that fuel, the race card can’t go around the track. You have to have positive cash flow in order to make investments in the people, in the systems and other equipment and things like that that are necessary to truly scale the business. So as a quick example, we have a professional services firm as a client that’s doing large multi-million dollar projects and they have municipal clients and they stretch out their payments 60 90 days plus. And these are large, large payments. And that causes a great deal of cash strain on the business. So they don’t have the fuel because they’re cash poor to really increase the business and increase the investment in sales and marketing. So we’re helping them raise some capital to get that fuel because the business itself doesn’t generate enough cash enough cash flow. Yes, but there’s lots of examples where cash flow is generated from the business, and that’s truly what you need to scale. 

Sean Magennis [00:02:47] You know, it’s it’s such a good point. You make, you know, one cash is king, you know, in your example, you know, aging receivables and the inability to collect on those in a timely fashion on big numbers. That’s a variable that that is sometimes very difficult to manage unless you have a great client relationship. We have a really good team that can help you with that. So thank you for sharing those particular examples because I think for our listeners, those are things that are very recognizable and understandable. So I’d like to get your thoughts on some of the best ways to think about finding cash to scale. I’ll take you through four things that we have seen and get your thoughts on each. So the first one is and this is in the form of of a of a question is why is cash flow more important than net income and EBITDA for a firm trying to scale? 

William Lieberman [00:03:44] Well, net income and EBIDTA are important measures of profitability. So how well, how healthy is the business, but they’re done on an accrual basis, not a cash basis. So they give you a picture of my generating enough revenue or how much revenue generated when my expenses to generate those revenues and therefore what of my profits? But that’s not the fuel of the business. That’s not how much cash is really being thrown off by those revenue generating activities. So if you are, you know, delivering $100000 worth of services and it costs you $60000, you make a $40000 profit. But what are you really collecting and when are you going to get that $100000? And they take a month or two or three. And so in some cases, your cash flow could be negative if you’re not collecting in a timely fashion on the revenue generating. But at the same time, you’re profitable. Yes. So you really have to look at cash all the time, as it is truly the key measure in order to know how much fuel you have to invest in the business to scale. 

Sean Magennis [00:04:47] Really well put simply put, very understandable. So the second issue it’s often said entrepreneurs mismanage cash flow. Do you agree with the statement? And if so, how can an entrepreneur prevent the lack of cash flow in their business? 

William Lieberman [00:05:05] Well, to answer your question, absolutely. Entrepreneurs mismanaged cash flow all the time. And by the way, it happens large public, multibillion dollar companies, too. Yes. It’s not just the smaller companies would happen. So what, what we really do and we do this for ourselves, we do this for our clients is we look at a 13 week, week by week cash cash. So how much are we going to collect from each of our clients? And what do we forecast for sales and how is that going to turn into collections? And then what are the operating expenses that we’re going to have to pay on a week by week basis for the next 13 weeks? And then as importantly, what are the cash expenses that are not operating? So do we have debt service? Do we have capital expenditures, maybe distributions and dividends, things like that? Yeah. So we get a full picture of all the ins and outs. And from there we know are we going to run out of fuel in the tank? And therefore, what can what do we need to do about it now so that we proactively, you know, don’t don’t run out of gas halfway around the track? 

Sean Magennis [00:06:07] You know, those are those are excellent. And so my challenge to our listeners going out would be to adopt exactly what William has said, the 13 week week, two week cash forecast. Clear understanding of expenses by week. And then other things that need to be service like debt service, etc. And you know, the ins and the outs, as you’ve said, I mean, absolutely vital. And I’m going to go out on a limb here, William, and say, if you’re not doing that now, there are people, there are specialists and advisors that can help you. Is that is that a good a good recommendation? 

William Lieberman [00:06:42] Yeah, absolutely. You know, we do that for our clients and there’s lots of firms out there that provide expert advice in terms of how to best manage cash flow and in your forecasting methodology. 

Sean Magennis [00:06:53] Excellent. So number three, I often see our listeners who are owners of boutique professional services firms trying to raise capital when they do not need it. They think they need X amount of capital to scale when in fact they’re often generating enough cash from operations to fund scaling. Now, sometimes this isn’t the case, but what do you think? What is your opinion on this concept? 

William Lieberman [00:07:19] Well, first and foremost, capital is expensive, outside capital is very expensive. You’re giving up a percentage of your business if you’re raising equity. And if you’re raising debt, you know debt can be risky depending on how much you get. So to the extent that you can always rely upon the working capital coming out of your business to fund investments to scale? That’s absolutely ideal. Right. So that’s that’s the critical piece to this is to make sure that you understand how much bit, how much cash is being generated and ensuring that you have enough fuel in that tank. So, you know, when you think about the forecast modeling that you should be doing it, every entrepreneur should be doing it. It gives you those knobs and dials of the business so you can decide how much cash you’re able to reinvest in the business versus taking it out as a distribution or leaving it in the business and not making any money. 

Sean Magennis [00:08:14] Right. And that’s a balance, right? How much can you reinvest should you build a certain cash reserve depending on the type of business you have? Is this is there forward visibility to a book of business coming in? I’m sure all those variables are in your knobs and dials. 

William Lieberman [00:08:30] Correct. And it’s one of the important things that we’ve seen is that entrepreneurs often make a mistake by relying upon the forecast from the salespeople, right, which are always optimistic. Salespeople are optimistic by nature. Absolutely. We always recommend have the CFO, you know, really look in at those forecasts and really dial it based on historical results of delivering on what the salespeople are saying. 

Sean Magennis [00:08:57] That is a great piece of advice and I’d like you have seen, you know, I’ve seen forecasting go go sideways when you have a disconnect between, you know, the accuracy of the forecasting and the reality of either previous business or what you’ve got actually in the pipeline. That’s great. So we’ve we’ve seen that one of the best ways to boost cash flow is to measure it correctly. And we have found the best way to measure it is at the project level. You know, when you measure cash flow in the aggregate, it can hide waste. What are your experiences in this? 

William Lieberman [00:09:33] Well, yes. You know, I love what you said because it’s it’s the whole and it’s you cannot measure it and cannot manage it and funds that right. Yes, I absolutely agree. If you look at things in an aggregate, there’s all sorts of hidden gotchas, hidden expenses that you wouldn’t otherwise see. So by looking at it, a profitability and cash flow on a project by project or client by client basis, you can see which clients are really generating the profits of the cash that are fueling your business and which ones maybe sucking cash precisely those ones. Hey, maybe when you make a decision here, guys about either firing the client or increasing your fees or decreasing expenses, whatever dials that you need to change, you need to do that on a client by client basis. And we look at that every month for our clients as an internal business, as well as helping our clients do the same for theirs. 

Sean Magennis [00:10:28] That’s extraordinary valuable. And you know, listeners, please take what William is saying seriously into consideration. Your ability to scale is directly proportional to your capability to have these dials, to have this detailed knowledge at your fingertips, project by project really, really manage your cash flow as carefully as you can, and you will be surprised at how it could potentially unlock additional source of sources of funding so that you don’t have to give away a high percentage of your business to attract an outside investor or an expensive debt source. William, thank you. It’s super clear that managing, measuring and boosting cash flow is key to scaling a boutique firm. So this will take us to the end of the episode, and this is customary. We end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool is a checklist, and our style of checklist is a yes no questionnaire. We aim to keep it simple by asking only 10 questions in this instance. If you answer yes to eight or more of these questions, you need to have a solution to cash flow. If you answer no a lot, you don’t have an issue. William has graciously agreed to be our peer example today. I will ask William the yes, no question so we can all learn from his example. Let’s begin. 

Sean Magennis [00:12:00] Number one. Will you run out of working capital if you double your firm? 

William Lieberman [00:12:07] And for us, it’s a no, we are completely virtual companies, we have really low overhead and our operating expenses are less than 10 percent of revenue. Fantastic because we use contractors to deliver our services. If we double our client base, we just add more contractors. And that’s the beauty of the accordion model.

Sean Magennis [00:12:27] I like it very clear. Number two, will you need short term debt if you double your firm? 

William Lieberman [00:12:35] For us, no. What we do is we keep an amount of cash on hand that covers our operating expenses in our contractor expenses, so we always have a minimum level. And as we grow, we increase that minimum reserve so that we never have to borrow money. 

Sean Magennis [00:12:51] Excellent. Number three, will you develop a collections problem if you double your firm? 

William Lieberman [00:12:58] So no, what we’ve done is put in place from the beginning from the sales point of sale understanding with the client. Here’s how we build. Here’s how we invoice. Here’s our net terms, etc. And then we have a formal process that escalates up if something looks to become a problem starting with client service, but all through invoicing and collections. And so we and we review it every week. 

Sean Magennis [00:13:22] So you have a weekly review process with triggers that alert you to any difficulties. 

William Lieberman [00:13:28] Absolutely. Finally, go through every client every week. 

Sean Magennis [00:13:31] Outstanding. So, William, question number four, will your cash flow payments exceed your cash income if you double your firm? 

William Lieberman [00:13:42] No, because our model is to have a very specific percentage, say, 55, 60 percent of what we believe to our contractors. So no matter how much business we’re doing. I know exactly how much cash is going out and how much we’re able to retain. And this, of course, assumes that we don’t have any collection issues which would solve.  

Sean Magennis [00:14:04] Outstanding thank you. Number five, will you have a hard time getting enough cash on the balance sheet to double your firm if you decided to do it? 

William Lieberman [00:14:14] No, because we have a very controlled growth plan in place, so we’re purposely not making large, large investments that outstrip our ability to fund from operating cash flow. So, you know, I always like to lead with. 

Sean Magennis [00:14:28] Good. So number six, when growth has spiked in the past, did your cash flow ever turn negative? 

William Lieberman [00:14:36] So this just happened recently where the answers no. But we had a big spike in quarter two of this year, and we had a best quarter ever way, way higher because we had a lot of one time money. So we build and collected and paid our our people and generate enough cash flow to pay out the partners of a significant distribution. 

Sean Magennis [00:14:55] Very nice. Congratulations. That’s a problem all our listeners should have. It’s great. Number seven, will payroll growth exceed accounts receivable growth when you double your boutique? 

William Lieberman [00:15:09] So because our contractor costs are 100 percent tied to revenue growth, there’s a one to one relationship between our growth and revenue. So, no, as the revenues go up, we pay out more. As revenues go down, we pay less. And so as we double it will, it will be perfectly fine. 

Sean Magennis [00:15:29] Excellent. Number eight, will cash flow problems be hidden due to lack of forward visibility? 

William Lieberman [00:15:36] No, because we implement, you know, we eat our own dog food, so we implement a 13 week cash flow forecast as we every week we update it and we can see what’s going on with cash. So we always have that forward visibility on here. 

Sean Magennis [00:15:49] Very nice, William. Number nine, will it be hard to generate the yield on your cash deposits? 

William Lieberman [00:15:57] Well, so assuming I understand the question, then this one’s a yes. Okay. If you mean cash that’s sitting sitting around in a bank or some kind of financial institution that doesn’t generate anything right? So we prefer to either distribute out to the partners and we make our own investments or preferably invest back the business. 

Sean Magennis [00:16:16] Excellent answer. That’s exactly what I was getting at. And then number ten, will you be at risk of paying your future obligations if you double your firm? 

William Lieberman [00:16:26] No, we have a very controlled model, so no, not at all. 

Sean Magennis [00:16:30] Outstanding, William. In summary, boutiques run on cash. They don’t run on net income or EBITDA, which is measured on the accrual basis. As you so rightly pointed out, do not run out of cash as you try to scale. A huge thank you to you, William, today for sharing your expertize and for our listeners if you enjoyed the show and want to learn more. Pick up a copy of the book The Boutique How to Start, Scale and Sell a Professional Services Firm. Written by Collective 54 founder Greg Alexander.

And for more expert support, check out Collective 54, the first mastermind community for founders and leaders of boutique professional services firms. Collective 54 will help you grow, scale and exit your firm bigger and faster.

Go to to learn more.

Thank you for listening.