Back in the days of compulsory military service, conscription notices ended with the sentence: „bring 3 days cold food to the barracks”.  The idea was sound, ensuring that conscripts were prepared for the worst eventualities.  Entrepreneurs would do well to follow this logic when acquiring companies.

What am I talking about?

Buyers typically bid for targets on a “cash and debt free” basis, meaning that bidders do not wish to be responsible for the debts of the company, but willing to pay extra for any cash in excess of the minimum needed for normal operations. The idea is to prevent sellers from weakening the balance sheet of the target between the offer date and closing.  Otherwise, sellers would withdraw all existing cash and even lever up the company and take that cash too to maximize their proceeds from the sale.

Notwithstanding the cash-and-debt-free clause, buyers may still lose, if they take over the company without a healthy cash balance required to fund upcoming salary or bonus commitments, or if there is declared but unpaid dividends to be honored by the buyer, post closing.  One investor in a currently closing transaction explained to me the “3 months cold cash in the till” principle, to ensure the bidder would not have to start by raising the capital of a newly acquired, cash starved target.

Cash is food, but targets need more. They should be bought with muscles and fat too making sure they are fit to sustain performance. For manufacturing and trading companies stock is the muscle and receivables are the fat, on which the company may live even if there are few new orders during the months after the takeover when the buyer is preoccupied with learning the company.