Module 3: Sources & Uses of Funds: Purchase Price, Working Capital Injections, Rollover Equity, and Closing Fees

Learning objectives and prerequisites

By the end of this lesson, you should be able to fund every economic and cash use once. Prerequisite knowledge: EV, seller proceeds and capital sources. Work from assumptions to equations, explain the acquisition consequence, and record the evidence needed to rely on the answer.

The acquisition price is not the funding requirement

An acquisition fails at closing if the buyer cannot explain where every dollar comes from and where it goes. A valuation model can support the seller's price while omitting legal costs, the guaranty fee, opening payroll liquidity, or additional inventory. Sources and uses turns an attractive commercial idea into a funded transaction.

A use is a transaction obligation or resource the project must fund. A source is capital actually supplied, including deferred consideration where appropriate. Total sources must equal total uses, but that equality is only a first check. Each source must be available, eligible, correctly timed, and represented consistently in the legal documents.

This chapter uses actual US dollars. Precision Valve & Actuator has an agreed $5 million operating purchase price with normal operating working capital delivered, excluding cash, financial debt, and real estate. The base transaction is a complete Initial Acquisition, so it includes no seller equity rollover. A later conventional example teaches rollover mechanics without suggesting that seller retention is permitted in the base SBA category.

Define the purchase perimeter before entering numbers

The purchase perimeter identifies the legal interests, assets, and obligations transferred. An asset purchase acquires specified assets and assumed obligations; an equity purchase acquires ownership in the entity, subject to agreed adjustments and protections. Either form can be discussed using enterprise value, but the route from EV to seller proceeds differs with the agreement.

If the seller quotes $5 million for a debt-free, cash-free operating business, the buyer should not automatically add all existing seller debt as another use. The seller may pay that debt from the seller's consideration. Alternatively, the buyer may explicitly fund a payoff while reducing seller equity proceeds accordingly. The schedule must represent the agreement, not a mixture of two interpretations.

For Precision, assume the seller receives $5 million nominal consideration and settles any excluded historical debt outside this buyer schedule. There is no additional target debt payoff in uses. This simplification prevents a common double count: paying the full debt-free value to the seller and also paying a debt balance already excluded from that value.

The inclusion of normal NWC is equally important. Receivables and inventory delivered with the business are not purchased a second time through an automatic working-capital injection. Additional capital can still be necessary for growth, seasonal timing, or balances excluded by the contract, but it needs a separate explanation.

Build uses from the bottom of the closing statement

Precision's largest use is $5 million seller consideration. Professional transaction costs are $100,000 for legal and accounting execution plus $50,000 for financial diligence and valuation. The current case's upfront guaranty fee is $110,000, calculated from the $4 million senior loan and its 75% guaranteed portion in Module 2.

Other lender and closing expenses are budgeted at $40,000. These are estimated allowable transaction costs subject to itemized lender review; the example does not assert that every origination or agent fee a lender might propose is permitted. An actual schedule should identify each payee and fee basis rather than put an unexplained percentage in “other.”

Opening unrestricted cash is $200,000, and a separately identified $100,000 incremental NWC requirement supports the initial operating plan. The $200,000 is the bank balance retained for liquidity. The $100,000 is assumed invested at closing in additional net operating assets, so it is not also available cash. Those resources must remain distinct in the opening model.

Precision uses	Amount
Operating seller consideration	$5,000,000
Legal and accounting transaction work	$100,000
QoE, valuation, and financial diligence	$50,000
SBA upfront guaranty fee	$110,000
Other itemized lender and closing costs	$40,000
Opening unrestricted cash	$200,000
Incremental operating NWC funded at closing	$100,000
Total project uses	$5,600,000

The case assumes these amounts form the lender-accepted project-cost denominator after review. Total economic uses and eligible SBA project costs can differ in a real deal. Maintain a separate eligibility column whenever a cost's treatment is unresolved.

Match sources to the same economic perimeter

The senior lender advances $4 million. The seller defers $400,000 through a non-interest-bearing full-standby note. The sponsor contributes $1.2 million cash equity. Total sources are $5.6 million, equal to uses.

Precision sources	Amount	Cash at closing?
Senior acquisition loan	$4,000,000	Yes
Seller full-standby note	$400,000	No; deferred consideration
Sponsor cash equity	$1,200,000	Yes
Total	$5,600,000

The seller receives $4.6 million cash and the $400,000 note, totaling $5 million nominal consideration. Cash sources of $5.2 million fund seller cash of $4.6 million, fees of $300,000, opening cash of $200,000, and incremental NWC of $100,000. That second, cash-only reconciliation proves the note was not mistakenly deposited into the operating account.

A seller note appears as a financing source because it reduces the cash needed to satisfy the agreed price. It is not cash raised from an outside lender. A model that records the full $5 million cash payment and also adds $400,000 note proceeds to cash overstates both the seller payment and available funding.

Equity required, equity credited, and equity ownership

The sponsor's $1.2 million is the balancing cash equity contribution. It equals uses of $5.6 million less senior debt of $4 million less seller financing of $400,000. That is an economic funding calculation, not the regulatory minimum injection calculation.

The case's 10% minimum injection is $560,000. The $1.2 million unborrowed sponsor cash exceeds it without needing seller-note credit. The $400,000 seller obligation remains debt economically even if a permitted portion could qualify for injection treatment. Distinguish the note's nominal amount, qualifying credit, and future repayment obligation in separate columns.

Ownership percentages are another question. An investor contributing most of the cash does not necessarily receive the same percentage of equity if other parties receive management equity or different security rights. The cap table must reconcile the economic agreement and program eligibility, but it should not be used to manufacture a source for cash that never arrives.

A $200,000 cash contribution and a $200,000 promise to work hard are not interchangeable in a closing funding schedule. A seller accepting less cash for continuing ownership can create a noncash rollover source in an eligible structure, but services alone do not wire money to the closing account.

Working-capital injections versus the closing true-up

Suppose normal operating NWC is included in the price at an agreed $650,000 peg. The seller delivers only $620,000 under the same definition. A dollar-for-dollar adjustment reduces consideration by $30,000. That reduction compensates for a missing resource; it does not prove the buyer needs $30,000 less operating capital.

If the buyer must restore the $30,000 immediately, add a $30,000 funding use while reducing seller cash by $30,000. Net project funding can remain unchanged. The business receives the capital it needs, while the seller bears the shortfall through reduced proceeds. Counting only the price reduction makes the acquisition look cheaper without restoring operations.

Precision's $100,000 incremental NWC is above the normal delivered balance and is already funded at closing. The operating forecast later subtracts an additional $50,000 annual NWC investment. Those are different amounts for different periods. Subtracting the opening $100,000 again in Year 1 CFADS would count the same investment twice.

Working capital also differs from minimum cash. Inventory and receivables can support future receipts, but they cannot necessarily fund tomorrow's payroll. A buyer should calculate both normal delivered NWC and required opening unrestricted cash from a collection-and-payment forecast.

Lender Red Flags & SOP Violations: using the working-capital line as an unexplained plug.

A large loan surplus labeled “working capital” needs a documented operating purpose and eligible treatment. A price true-up, a cash reserve, and investment in stock or receivables are different uses and should not conceal one another.

Rollover equity in a separate conventional example

Rollover means the seller retains or reinvests an ownership interest rather than receiving all consideration in cash or debt. It can align incentives and reduce closing cash, but creates governance, valuation, distribution, and exit questions. Its permissibility under an SBA transaction depends on the category and retention rules discussed in Module 2; Precision's complete Initial Acquisition includes none.

Consider a conventional equity purchase with a negotiated seller equity value of $5 million. The seller rolls $1 million into continuing equity, receives a $500,000 note, and receives $3.5 million cash. Add $200,000 transaction costs and $300,000 opening liquidity to reach $5.5 million total economic uses. Senior cash debt of $3 million, seller rollover of $1 million, seller note of $500,000, and new investor cash equity of $1 million balance those uses.

Cash sources are $4 million, matching $3.5 million seller cash plus $500,000 fees and liquidity. Noncash sources equal $1.5 million, matching the consideration retained as rollover and note. The seller's final percentage ownership depends on the capitalization and rights agreed, not simply $1 million divided by operating EV if different securities or transaction steps are involved.

Do not use this example to propose a hidden continuing seller interest in Precision. A model can illustrate conventional M&A economics while explicitly ruling the structure out for a different financing program.

Timing: prepaid costs and cash still required at closing

A buyer often pays diligence costs before closing. Assume Precision's sponsor has already paid the $50,000 diligence budget and the lender accepts its treatment under the applicable project and injection rules. Total project uses remain $5.6 million; that $50,000 has already been spent rather than disappearing.

The remaining cash equity to wire is $1.15 million, but total invested sponsor equity remains $1.2 million. The return model should include the earlier contribution at its actual date if using XIRR. A simple annual case can aggregate it at time zero if that timing simplification is stated.

A refundable deposit also needs careful treatment. If credited against seller consideration, it is a prepaid portion of an existing use, not an additional purchase cost. If forfeited because the deal fails, it becomes a different investment outcome rather than part of the completed transaction's seller proceeds.

Maintain columns for total economic use, prepaid amount, closing payment, financing eligibility, and proof of settlement. This is how the funding schedule becomes a closing tool rather than only an investment memo exhibit.

Financed fees and circular funding

The base senior principal remains $4 million and the $110,000 guaranty fee is paid from project cash. If the lender instead permits financing that fee, principal can increase, which changes debt service and potentially the fee itself. A fee calculated on guaranteed principal may then require solving a circular funding relationship.

Suppose a simplified fee is 2% of gross principal and net cash needed before that fee is $1 million. If the fee is financed entirely, gross principal L satisfies L = $1,000,000 + 0.02L. Therefore L = $1,000,000 / 0.98 = $1,020,408.16, and the fee is $20,408.16. Adding only $20,000 would leave an unfunded residual.

This simplified algebra is not Precision's actual fee schedule. The lesson is to use the correct brackets, guarantee percentage, and loan limit, then resolve the dependency explicitly. Do not increase borrowing until sources balance while forgetting that higher principal increases service and may breach a program ceiling.

Opening accounting does not equal the funding table

Sources and uses records how the transaction is financed. Purchase accounting determines how acquired assets, liabilities, goodwill, transaction expenses, and financing costs are recognized. Tax allocation can differ again. A balanced funding schedule does not justify capitalizing all fees into goodwill or assuming all costs are immediately deductible.

For the LBO return model, every sponsor-funded cost reduces investment proceeds regardless of its accounting classification. For the income statement, the timing and classification follow the relevant framework. For cash taxes, deductibility and amortization require their own schedule if material. These three perspectives can coexist without contradiction.

Precision's textbook case treats the listed closing fees as time-zero cash uses and does not claim an immediate tax deduction for them. Recurring D&A and prospective operating cash taxes are separately specified. This avoids inventing a tax benefit merely to make the acquisition appear more financeable.

Controls that make a funding plan reviewable

The first check is sources minus uses equals zero. The second is cash sources minus cash uses equals zero. The third reconciles nominal seller consideration to cash, notes, rollover where applicable, and any escrow. The fourth compares required and qualifying injection without reclassifying debt as accounting equity.

Also confirm that loan proceeds remain within the approved gross amount, fees are calculated from the correct base, and all conditional sources are clearly identified. A term sheet, an expression of interest, and funded cash are different stages of certainty. A closing schedule should say which one exists.

The final judgment is economic. If funding balances only by eliminating opening cash below payroll needs, the transaction is not adequately financed. If it balances by assuming an unapproved seller earnout, the numbers are not executable under the stated SBA acquisition rules. A useful model identifies the exact missing capital or incompatible term rather than hiding it in “other sources.”

Self-Study Problem Set

Problem 1: balance Precision twice

Reproduce total sources and uses, then reconcile cash funding after separating the seller note. Calculate the sponsor's cash contribution.