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What is Working Capital and how does it Affect an M&A Transaction?

In the simplest terms, working capital can be defined as current assets less current liabilities but ultimately it is the amount of operating liquidity or cash available to a business at a given point in time. Working capital is an essential part of the day to day operations of a business and is just as important as employees and physical assets.

When selling a business the buyer will often require a normalized level of working capital so that the business can continue operating seamlessly and fulfill obligations to customers and creditors post-acquisition.

In a merger or acquisition, one of the most difficult parts of the transaction is often negotiating the amount of working capital that remains with the original business. Naturally this can be an emotional topic for the seller, and should be taken care of as early as possible. In nearly all transactions there will be some form of working capital adjustment as part of the purchase price agreement. A mergers and acquisitions advisor is instrumental in getting both parties to agree on the way working capital will be calculated, making for a much smoother transaction.

What is considered in a working capital adjustment?

Advisors will begin by looking at the selling company’s current assets over current liabilities on a monthly basis. Typically this process will start with the current month and go backwards over the most recent twelve trailing months but could go back as far as the past thirty-six months. It will be critical to understand the accounts receivables and how quickly the company collects revenue (and if all of this A/R will actually come in). It is also imperative to understand the current liabilities and the relationships associated with these debts. Advisors will keep in mind the type of business, industry, demand, market changes, competition, seasonality, and more.

How does this affect the sale price?

We can best illustrate this using a hypothetical example. For instance, a transaction may have a purchase price of $25M based on the seller including $4M of working capital at closing. The purchase price would depend upon the final amount of working capital provided by the seller. If the seller delivers only $3M of working capital, instead of the original $4M, the purchase price would be adjusted down to $24M. Similarly, if there was $5M of working capital at closing, the transaction would increase to $26M or the seller would be allowed to remove $1M of assets from the business and retain the $25M transaction value. Note: sometimes buyers and sellers will agree to a range or band and if the working capital falls within this range, there is no adjustment. Using the same example above, if the Working Capital came in within $1M of the $4M Working Capital Target (in either direction), there would be no adjustment.

Working capital is involved in every merger or acquisition transaction. It is vital to have a trustworthy advisor working on your behalf. Armed with decades of knowledge and your best interest at heart, the right advisory can ensure you walk away satisfied with your deal.

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