Negotiating working capital is one of the more challenging issues in closing a deal. Buyers and sellers often negotiate an acquisition on a cash-free, debt-free basis. In these cases cash, lines of credit and notes payable are all excluded. This can end up being more complicated than it initially seems. Ultimately, the amount is negotiated between the parties, with the buyer often valuing the business based on an EBITDA multiple or expected cash flows of the business. In buying the cash flows, all of the assets that are used to create those cash flows would normally be acquired. This includes the fixed assets, workforce, trade name, technology, intangibles and goodwill as well as a proper amount of working capital.
The purchase agreement will need to fully define the components of working capital, as the typical definition of current assets less current liabilities is not enough. Are bank overdrafts included or excluded and what is done with loans due to or from employees, owners or officers? How are greater than 90 day receivables handled? Obsolete Inventory? What happens with customer deposits, deferred revenues and deferred taxes? As we can see, a close review of the components of current assets and current liabilities is needed.
Purchase agreements can set working capital targets. Setting targeted working capital is generally based on an analysis of the business to identify the normal needs for working capital. Parties may agree to an estimate of Closing Working Capital at closing and adjust the closing cash payment. There may be no adjustment based on the estimate as of the closing; final true up is based solely on target working capital and the amount of actual Closing Working Capital.
Each scenario is different and an unbiased third party review of a potential merger or acquisition is often coveted after the transaction has occurred. Please contact one of our valuation specialists; Keith Rutherford, Terry Delaney, Bob Dale or Harris Widmer if you are considering a merger or acquisition.