Post-closing Considerations: Cutoffs

Some intermediaries only offer assistance till the deal closes. In this episode, we explore the complexities of cutoffs in business transactions, a critical aspect often overlooked by first-time sellers. We break down what happens at closing, from accounts payable to inventory cutoffs, and discuss how to handle the transition period smoothly. Whether you're a business owner planning to sell or a buyer looking to avoid post-closing surprises, this episode provides valuable insights to help you prepare.

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TRANSCRIPT:

Welcome to Integrated Insights with ICCG. For more than 30 years, our team has

partnered with small business owners to prepare for and navigate the business

transaction process. Pull up a chair as we share stories and insights from our

experience on all sides of the M &A table. And welcome back to another episode of

Integrated Insights. My name is Michael Hefner. I'll be your host today. I'm joined

by the founders of ICCG, Grant McWilken and Dave Parker. Thanks guys for joining me.

Thank you. Thanks for having us again. Yeah, today we're going to be talking about

cutoffs. So a lot of business owners that may not have experience doing business

transactions in the past, they may just think that, you know, as soon as as as

soon as closing happens, they're done, right? Nothing else occurs. But the fact of

the matter is, hey, there are close -offs that occur, or cut -offs that occur at the

time of closing, but some are more of a transition over time. So we're gonna talk

about that difference today. So to get started, let's talk about cut -offs that

happen at closing. Some of those like accounts payable, what do those look like,

and why do they happen at closing versus as a transition period. - Yeah, so let me,

I'm gonna turn this over to Grant, let him kind of lead the dance on this one,

but I wanna say out of the shoot that if you're listening, that this is super

important, especially if you're thinking about selling your business, because it has

everything to do with how you can be as smooth as you want to up to closing, and

everything can go really in a south, it can go south quickly after closing,

if the if the transitions aren't correct, because you build up trust, you build up

trust, and all of a sudden something wonky happens and you think, oh, one side is

accusing the other of not being distrustful. And that's when things can really fall

apart. So I think it's really important that what Grant's gonna talk about is taking

a heart and is also scripted really, really clearly so that everyone understands

their responsibilities, and then there is no issue. It's also up to us and the

client to really understand their own business, right? So some people recognize

revenue when they receive the money, for example, and some people recognize revenue

when they build a client, build their customer. And so understanding that and

understanding the revenue cycle, understanding, you know, that the whole process of

accounts payable, the process of inventory kind of gives us a heads up on how we

need to handle that cutoff, right? And the most common way that we do that is we

put in a formula called working capital and we can always go back to that video,

but We script what those cutoffs are going to look like,

and the hope is, is that while there might be some reconciliation at closing,

that the buyer has the best view of what that cutoff was because he has hindsight.

He can go back and actually see exactly what what it ended up being.

And then there's a settlement of who owes what 60 or 90 days later.

I think actually scripting those cutoffs is super important in understanding exactly

the timing of it, but also how the business works. We've just closed a deal in the

medical world, in the medical service world where we close at 7 p .m.

because that's when the shift ended. And so it makes the payroll cutoffs really much

easier and it's very easy to see the time that a patient was seen based on the

medical history and therefore the claims that happened prior to that or the revenue

that and prior to that, it's easy to get the cutoffs. Whereas if we made it

midnight, we'd have to, which is where most closings happen,

effective midnight is in that particular world would have been a little bit more

awkward and subjective with regards to labor and whatever else they use when they

see those patients. - Or you may choose the end of a payroll period, right? - Yeah.

- Which could be the midnight or the seven, you know, depending on what the business

is, but end of a payroll, then you're not, sometimes you're giving out a short

paycheck, which then throws the employees off. And whatever, I'd say, whatever these

cutoffs, whatever you can do to keep the consistency in that business,

especially with your employees, and make sure that they're not affected, they're not

affected negatively by what's going on much much better off. If you've got 250

employees that you have to onboard and then pay payroll in three days time that's

just really difficult and so working through those you know who's gonna pay what is

super important ahead of time so that there are no surprises and a rat race at the

end. Yeah. And I'd also say that make sure that the intermediate you're working

with, if you're working with, and hopefully you are working with one, is someone

who's capable of helping you through all this. Because, you know, I think in some

cases, a broker may come along and just when the deal's done, they're on to the

next one. But, you know, we really try to work with our clients and make sure that

the script is followed out. And sometimes that takes a long time, it takes weeks. I

mean, I I know Grant has gone in and helped with reconciliations on working capital

cutoffs and then that drew up, you know, six months later, three months later,

whatever it is. Yeah. I think just understanding that there's an issue is super

helpful for our clients as well because we can go through the balance sheet and the

income statement and see what is going to be an issue. And so, you know,

going, going, dang it, I forgot to take inventory of supplies or I forgot to take

inventory of work and process or those kinds of things, well, you can't reinvent

that. It's just almost impossible. And so it just is another reason why there might

be conflict between a buyer and a seller after the fact. And Like Dave said,

you want to reduce that possibility as much as possible by creating certainties.

Anticipating what you need to do is super helpful. Some things are very easy to do

ahead of time. For example, advertising expense, you typically prepay that.

You know, You booked the trade show in six months time, you paid the fees already,

so it's a prepaid expense. Things like rent. You know that if you close on the

15th of the month, then there's going to be 15 days of prepaid rent or 16 days of

prepaid rent depending on the month. So those, you can allocate ahead of time.

You know exactly what that is. inventory is difficult. If we have a very,

if inventory is a very, you know, big part of the balance sheet,

then you've got to set up the process to where the count is done.

You know, at the same time, the revenue cut off is done, right? And the biggest

hassle that we ever have is work and process. And so if you've got a,

you know, manufacturing company with, with, you know, 60 machines humming all the

time, then understanding how much labor and materials has gone into those jobs that

have not been billed yet, or maybe they've got advanced payments, those are,

those are difficult in their processes that that the client is not used to doing

typically, at least not with the accuracy that a buyer and seller want at closing.

And so we have to go in there and talk to them and find out how they normally do

it and then change their processes a little bit so that it'd be satisfactory to the

buyer. Yeah, another one would be construction, Right? Because construction, you've

got, you may have had, you've got your different payments that are happening along

the way to the contractor and they may have been preloaded on some of those

payments, right? So they may have been already paid for work that was done in

advance that isn't completed yet. So then there's a whole other calculation, right?

Yeah. The percentage completion calculation happened In a plumbing company that we did

that was very focused on multi -family construction,

and so they had massive contracts that were a certain percentage complete,

and that calculation has some estimates in there, and it can really,

really change the working capital formula if you get those incorrect.

And so part of our job is to create trust in the buyer's mind by giving an

adequate amount of time for them to justify that percentage completion calculation in

hindsight.

- Without going too deep into it, Grant, on process, you know,

you just talked about a lot of the complications that can happen at closing with

the cutoffs and stuff. But we also see a lot of companies that, you know, quote

unquote, should have working capital that don't. Why is it, is it worth it to deal

with that hassle or is it better to just not have working process even if that's

typical for your industry? Yeah, I mean, we see and In fact,

Michael, you and I looked at a couple of balance sheets that we know there's work

in process, but they just don't track it. It really depends on our communication

with our clients and how important that is. When we sat down with a guy a couple

of days ago and asked him about work in process and goes, "Ah,

you know, I don't know what it is," or whatever. And then we kind of ask some

questions and it's a few hundred thousand dollars. Well, it doesn't really change the

P &L from a buyer's perspective because there's a beginning balance at the beginning

of the year and an ending balance at the end of the year. And so if you're doing

the same amount of business, then it's a wash on the P &L. But when you're buying

a all of a sudden you've got you know half a million dollars worth of work in

process inventory it's never been on the balance sheet how do you deal with that

with a buyer the buyer doesn't want to pay for it because it was never on your

balance sheet to begin with and the seller's going man I earned some money I spent

a lot of money on those jobs you're just gonna finish them up and then bill it

and so those are the kinds of conversations that we talk Um,

with our clients and make sure that there's a solution and I would say as a

seller, if you're going to come to the table, you know, if you're looking to sell

your business, think of all those things that, you know, all these questions are

rattling in your back or my mind, your mind, not my mind, your mind that, you

know, like, I've got, you know, $100 ,000 worth of pipe in the back in the

backyard. What I do about that, you know, all those different things, think of them,

Think of them ahead of time because we've had a lot of clients that think of them

the day of closing and that's too late to think about it. It's like, "Oh, by the

way, well, it's a little late," you know? Yeah. And then you get this crazy

conversation where the seller says, "Well, if you're not going to pay me for it,

I'll just take it." Yeah. It's like taking that pipe. No, The reason why it's not

on your balance sheet is because you're written it off.

You're selling 100 % of the assets that are in the business and so that's included

unless you've thought about it ahead of time and warned the buyer, right? That's

great. Yeah, I just think about the best time often to sell to bring your company

to market can be when you're growing. So, if work in process is what helps you to

capture that growth.

of work and process at any given moment is just not tracked on their financial

statements, unfortunately. So to this point, we've mostly just talked about cutoffs at

closing. So let's transition a little bit to the items that take a little bit of

time to transition or things that might come up, right? And Dave, you mentioned at

the beginning, things might go wrong and how do you deal with some of those things?

What are some of those items? What does that look like? Now, I'll remind Dave of

one that is difficult, Davis has quarterbacked some transactions in the medical

industry and the service providers uniquely have a bank account associated with the

payer, with the insurance company. So, for example, Blue Cross will have a claim

that then is paid to the claimants,

to the service provider's bank account. And to change that bank account is extremely

difficult, and you may not get paid at that point. And so, the buyer has to have

control over the seller's bank out at closing, which is really unique to that

industry.

Normally, you just tell the customer, "Hey, send it to me and not to Joe Seller."

Because I've just bought the company and the seller communicates with that client and

everything's fine. But in this huge, huge company environment,

that is the insurance medical insurance business, it is extremely difficult to change.

And so it warrants a little bit of a special workaround.

And this is where I think Dave is so good about,

okay, here's the problem. Let's find a solution. And And so, it produces all kinds

of crazy reconciliations with regards to cutoffs, but it's doable,

but it creates an environment where you have to work with each other in order to

get it done the way that the documents script. Yeah, you have to trust each other

on that one, and that particular situation only applies if they're buying part or

all of the accounts receivables, because all the past claims have to go into that

bank account. There is no other, they're tied to some specific billing numbers,

and they have to go into that bank account. So there has to be some give and take

on this. In some cases it's been really, really simple, and everyone understands it

in other times that we would just say it hasn't hasn't been so easy.

Well, I think, you know, and I think it's also applicable to other industries as

well, where you have vendor contracts, where you have customer contracts that you

need to pursue to make sure that those banking details are changed,

for example, but there's going to be issues issues, and just knowing ahead of time

what they might be and arranging for that, hey, you're going to get a payment from

such and such a customer. When you get it, would you forward it to us, basically?

We've tried to change the uniform companies draft out of our bank account.

This is a classic example because dealing with uniform companies is almost impossible.

But they keep on drafting the payment out of the seller's bank account, and so the

seller needs to keep the bank account open to clear up any last -minute distributions

and all those kinds of things, and then he gets dinged for a $1 ,000 uniform bill.

So you can get mad about it, or you can already have the heads up from the

intermediary saying hey you probably are gonna get some bills but that's okay because

there's a hold back to cover it but there's also a process where you can just

submit those to the to the buyer and the buyer will cover those bills.

Talk a little bit more about that vendor stuff So, you gave a really good example

there, Grant, but what about like continuation or changing of vendors? What does that

look like after closing? Well, that just takes a lot of cooperation.

Once again, you may have a strategic buyer who's coming in who has other locations

or other similar type businesses. They're bringing in some of their own vendors. All

that needs to be fleshed out in due diligence And there's schedules in the purchase

agreement that will kind of outline who the current vendors are, who the contracts

are with. And it's really important as a seller to make sure you've listed

everything because there's going to be some of those vendors who you need to cancel

and a buyer may not, they're not gonna be responsible for canceling someone they're

not going to use. And that has also been a source of contention. Or a buyer comes

in, is grants mentioned, is wanting to change a vendor or is wanting to use a

vendor, but they find there's a past due amount. You try to find out as much of

that as you can during the due diligence process and then make sure that it's

listed on these schedules so that everyone's aware. Even with that, things slip

through the cracks and they just have to be dealt with, but vendors like to know

that they're going to be paid for their past bills, which is why a working capital

true up works really nice because working capital calculation like we use allows then

for us to go off and pay those past bills and it becomes a credit to the buyer

for that working capital calculation. But that just takes time.

You think about these cycles of you may have a vendor it's once a quarter, it

might be a maintenance person who's coming in to check the HVAC. All those things

kind of come up as time goes on. And we just tell the seller, if they haven't

been,

this is one of the reasons I think Grant has a great idea. He always tells the

seller that if you're not needed or they're not gonna contract to have you around

any longer or maybe after the three or six month period that you're be there. Have

them pay for your cell phones so they know they can get a hold of you.

They're going to call and say, "We've been trying to get a hold of this vendor. Do

you have any contacts over there?" Whatever. Just those helpful pieces. By all means,

if you're the seller and you're going to offer that, answer your phone. We had a

nightmare situation happen with one of our clients. We helped them sell their

companies and two years later, they got sued.

The reason is because the buyer built up all this over $100 ,000 worth of bills on

this particular vendor, but the buyer did not change the account.

And so they were responsible for it because it was their contract.

And so you have to be really careful with as a seller to make sure that if you

have guaranteed any of that stuff or if you are on the hook, then you remain on

the hook as long as they're using your account. And so just that and and you know

I would get some some advice from the intermediaries for sure but there's some

business street smart sense over there that you need to go okay these guys can

build up and build up and then I'm still on the hook your lawyer will say well

there's indemnities and all kinds of stuff but there's not a whole lot of ways In

that particular case the buyer two years later went bankrupt and so the

indemnification is worthless because they can't go after the buyer at that point and

so the seller is stuck with negotiating this $100 ,000 supply bill which is awful.

Great example of why to prepare for it and expectations that you can have for it.

Hey, before we wrap up, do y 'all have anything else you would share to business

owners just regarding expectations and preparing for cutoffs? Yeah, I think that the

last thought I would say is, obviously, you know, having experienced intermediaries

that kind of walk you through ahead of time, as a business owner, you're smart

enough to know where your exposure is. but one of the most important conversations

that needs to take place and business owners don't really want to take, want to

talk to the insurance agent about selling because because they sometimes they are the

same insurance agents for their competitors. And so knowing whether your insurance is

event based or claim based, you know, whether you're going to have to purchase a

tail policy. You never want to be without insurance. And so,

you know, insurance is one of those things that can go away the day you stop

owning the business. And then if a claim happens a month later on a job that you

did before you before you sold, you don't have any insurance. And so just be

careful with that. And just It's important to engage your insurance professional at

the right time to determine whether you have any exposure there. - Exactly.

- That's awesome. Yeah, I think we've said on here a lot in the past. Business

owners that we work with are really good at what they do. We know a lot about

what's customary and what your options are regarding business transactions. So, we'd

love to sit down with business owners to help walk through a business transaction as

a whole, as well as the cutoffs associated. So, but hey, guys, thanks for joining

me today. That's all the time we have, but we'll see you next time. Thank you,

Michael. Thank you.

And that wraps up another episode of Integrated Insights with ICCG. Be sure to

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listeners. If you have any questions or topics you'd like us to cover please send

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