How do search funds handle working capital requirements at acquisition?

Working capital management represents a critical but often underestimated component of search fund acquisitions. Many first-time buyers focus heavily on enterprise value and debt structure while inadequately planning for working capital needs, leading to post-acquisition cash flow crises. Working capital—the difference between current assets (cash, receivables, inventory) and current liabilities (payables, accrued expenses)—represents the operating cash required to run the business day-to-day. At closing, the acquisition agreement must specify a normalized working capital target based on historical analysis of the business's operating cycle. This target typically reflects average working capital over the trailing twelve months, adjusted for seasonality and one-time items. The seller delivers this amount of working capital at closing, with post-closing adjustments if the actual delivered amount differs from target. Calculating working capital needs requires understanding the business's cash conversion cycle. Companies with long production times, extended payment terms to customers, or significant inventory holdings need more working capital than service businesses with quick cash collection. For example, a distributor extending 60-day payment terms while paying suppliers in 30 days must finance 30 days of sales as working capital. Seasonal businesses face particular challenges—a landscaping company might need significant working capital in spring to purchase equipment and hire staff before revenue arrives, while a retail business requires inventory buildup before holiday seasons. The acquisition financing must provide not just purchase price but adequate working capital. Common structures include a working capital facility or revolving credit line separate from acquisition term debt, allowing draws when cash needs spike seasonally. Many searchers underestimate working capital requirements because they focus on profit-and-loss statements rather than balance sheet dynamics. A profitable business can face cash crises if working capital absorbs cash faster than profits generate it. Growth exacerbates this—increasing sales require proportionally more receivables and inventory, consuming cash even as profits rise. Post-acquisition working capital management becomes an operational priority. Searchers must implement rigorous credit management to reduce days sales outstanding, negotiate better payment terms with suppliers, optimize inventory levels to minimize capital tied up in stock, and monitor cash conversion cycles weekly rather than monthly. Board members often provide guidance having experienced working capital squeezes in their own businesses. They help searchers distinguish between permanent working capital needs (the baseline required to operate) and temporary spikes that can be financed with short-term facilities. Failure to manage working capital properly appears frequently in search fund challenges. Companies miss debt payments not because they're unprofitable but because cash is trapped in receivables or inventory. Vendors cut credit terms when payments slow, forcing cash purchases that further strain liquidity. The death spiral accelerates if the searcher doesn't understand root causes. Successful searchers establish working capital metrics and targets immediately post-acquisition, implement weekly cash flow forecasting showing projected receipts and disbursements, create aging reports for receivables with disciplined collection processes, and negotiate adequate banking facilities with flexibility for seasonal needs. The difference between adequate and inadequate working capital planning often determines whether the critical first year post-acquisition succeeds or becomes a crisis.