Seasonality can have a drastic impact on the amount of working capital required to run a business, which is why it is frequently cited as one of the primary revenue-related challenges in negotiating the working capital adjustment in a private equity transaction (aka “the working capital peg”).

To emphasize this point, imagine that you have an opportunity to buy one of two businesses. In this hypothetical scenario, both companies generate $10 million of profit selling 1 million pool floats per year at a price of $30 dollars each. Financially, everything about these two businesses is identical apart from monthly sales volumes and the liquidity required to support these volumes. In other words, the primary discrepancy relates to seasonality.

In both scenarios the company makes $10 million of profit selling 1 million pool floats at an average price of $30 dollars each. But this “low seasonality” business, which clearly operates in a fantastic geography where people buy pool floats year-round, requires substantially less liquidity to achieve the same economic result.

In fact, the highly seasonal business requires more than 3 times the amount of liquidity to make the same amount of profit!

The best way to communicate the value of this discrepancy to an entrepreneur or CEO is to ask them to imagine that they own the business in its entirety (some of them already do); and then explain that if they can find a way to reduce seasonality the difference in liquidity can be transferred from the company’s balance sheet to the owner’s bank account.

Read the full article, here.

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