An Asset Buyer’s Windfall: Financial Benefits From Collecting Seller’s Accounts Receivable

Frequently in an asset acquisition involving a substantial portion of the seller’s business, the seller’s concern about the erosion of collectibility resulting from a decreased incentive for account debtors to pay pre-closing receivables after the asset sale will create an opportunity, mutually beneficial to both buyer and seller. Although the buyer may not want to acquire the accounts, for purposes of business or good will continuity or otherwise, the acquisition of this asset may enable the buyer to obtain significant financial benefits from the float of the fund of collections occurring between the time of collection and the time when the buyer must remit to the seller.

A properly implemented strategy for the purchase of the seller’s receivables in the acquisition contract negotiations will enable the buyer to obtain significant financial benefits, including the interest-free use of the float fund and, perhaps, the ability to finance a portion of the asset acquisition transaction, as a trade-off for alleviating the seller’s collection concerns.

The implementation of the strategy pre-supposes the existence of certain elements within the circumstances of the transaction:

• an arms-length transaction between unrelated parties;
• an average time-lag or float between the time of the collection of the receivables and a contractually stipulated time for repayment of sufficient length to provide a realistic use-of-money benefit (e.g., a minimum of 60 days) without charge to the buyer;
• an aggregate amount of acquired accounts receivable (a minimum of about $100M), as well as an anticipated rate of collection, of sufficient magnitude to provide meaningful benefits to the buyer;
• an historically low rate of uncollectibility of seller’s receivables; and
• continuance by the buyer, following the closing of the acquisition transaction, of supply to customers of the business of at least a significant portion of the goods or services previously provided by the seller.

The buyer must insure that appropriate provisions to implement the strategy are included in the acquisition agreement. Though these provisions will vary somewhat with the circumstances of the transaction, certain basic provisions should be included:

• The portion of the total acquisition price allocable to the accounts receivable should be their face amount, less discounts for administration, buyer’s out-of-pocket costs of collection and a negotiated “profit” for the buyer for its collection handling;
• The buyer’s obligation to remit to the seller should be based upon a stipulated float time (e.g., at least 60 days, but preferably 90 days or more) from actual collection, or a specified time period determined by the seller’s historic accounts receivable turnover rate, whichever is later, so that the buyer will not be prejudiced by delayed payments and will benefit by early payments;
• The purchase price should be subject to reduction by the actual amount of uncollected receivables as of an outside date for a final accounting and determination of the buyer’s remittance obligation – between 270 and 365 days following the acquisition closing is normal, although the buyer should attempt to negotiate a more extended period; and
• Specific mechanics for approval by the buyer of the institution of collection proceedings and for the payment of the costs of collection may also be implemented in the acquisition agreement, including a provision for the setting aside, from the amount of collections, of a fund to finance collection costs.

The “seamlessness” of the transaction will foster the collection of the seller’s receivables outstanding at the acquisition closing date in accordance with the seller’s historical rate of accounts receivable turnover. It is, therefore, reasonable to anticipate that all of the seller’s receivables (less an historical low rate of bad debts) will be collected no later than within a period determined by the seller’s normal rate of turnover of receivables. Nevertheless, the buyer’s contractual obligation to remit collected accounts should not accrue until the later of, the expiration of the stipulated float time, or the specified historical accounts receivable turnover rate.

The financial benefits to the buyer attendant upon the use of this strategy are substantial. Using a hypothetical of $100M of acquired receivables, assume that the negotiated time-lag for the buyer’s remittance of proceeds from seller’s receivables is at least 90 days and that, based upon the seller’s historical receivable turnover rate, one-third of the outstanding accounts are collected each month on an even daily basis. Even under these fairly rapid turnover circumstances, and assuming the buyer’s average cost of capital¹ is only 5%, the resulting interest-free benefit to the buyer would be in excess of $1.4M. If the buyer’s average cost of capital were 10%, the benefit would be in excess of $2.8M. Assuming a contractually stipulated time-lag of 120 days the interest-free benefit to the buyer would be in excess of $1.8M at a 5% average cost of capital, about $2.8M with a cost of capital of 7.5%, and in excess of $3.7M if the average cost of capital were 10%.² Patently if the aggregate fund of seller’s receivables were larger than we have assumed, or, if the turnover rate were more rapid or the negotiated time-lag, attenuated, the resulting benefit to the buyer would be proportionately larger. In addition to the interest-free benefit the buyer should be able to obtain a reasonable “profit” (such as 0.5% to 1% of the aggregate of the accounts receivable) for the management of the accounts receivable collection in behalf of the seller. Thus, adding the “profit” to the buyer’s interest-free benefit, under our various assumptions, the buyer will receive a benefit ranging from a minimum of about $1.9M to a maximum in excess of $4.7M.

The interest-free benefit of the strategy constitutes only its narrowest potential value to the buyer. If designed to enhance the buyer’s flexibility in the available uses of the float, it may be utilized as financial leverage, either to offset a portion of the purchase price in the acquisition transaction, or, in combination with the stream of interest flowing from it, as security for letter of credit and other bank financing at a very low cost. In many asset transactions which present the conditions which are favorable to the implementation of this strategy, the seller’s accounts receivable significantly exceed the value of the aggregate of all other transaction assets, so that the implementation of the strategy will enable the buyer to obtain interest-free and profit benefits aggregating in amounts which are equal to a substantial portion (and sometimes all) of the total value of the non-accounts receivable portion of the asset sale. Such a situation presents the buyer with a ripe opportunity to set-off that portion of the purchase price against the buyer’s benefit.

Moreover, there are few, if any, drawbacks to the buyer. If planned correctly from an accounting standpoint, there should be no imputed interest or other adverse income tax implications to either the buyer or the seller arising from the implementation of this strategy. The buyer should be insulated entirely from the costs of collection and bad debt losses. Administratively, collections can be handled within the seller’s existing channels with no cost enhancement, and administrative costs may be passed on to the seller.

There are substantial incentives for the seller accepting the elements of this strategy. The seamless continuity of collection afforded by the buyer’s integration of the seller’s pre-closing receivables with its own post-closing receivables provides the seller with a substantial degree of comfort in the continued collectibility of its outstanding accounts, particularly since the account debtors will be reliant upon the buyer’s post-closing continuity in the supply of goods or services formerly supplied by the seller. In addition, the availability of the seller’s receivables and proceeds therefrom as security for the buyer’s remittances to the seller renders the seller more amenable to extend the time-lag as consideration for the advantages provided to it by the continuity of collections afforded by this strategy.

The strategy suggested here offers a solution to the frequently existing problem in asset acquisitions as to the manner in which the seller’s pre-closing receivables should be collected. It rests its justification upon the underlying mutuality of interest of the seller and the buyer in providing seamless continuity in the seller’s business following the closing and fuses the seller’s need for assurance of account receivable collectibility with the buyer’s financial benefits and its strategic position as the continuing operator of that business. The merger of interests that this strategy exploits is natural and mutually fruitful. The necessary circumstances for the viability of this strategy are special but by no means unique; they occur regularly in transactions involving asset sales of $100.0M or more. There are, to be sure, issues pertaining to this strategy which must be resolved in the negotiations between seller and buyer and necessary mechanics to be implemented in the acquisition agreement. However, the mutual benefits to be derived by the parties should easily drive the resolution of the issues and the mechanics may be readily implemented and followed.