Are you thinking ahead to your M&A negotiations and wondering what the best method is to resolve sticking points that may arise? In this video Partner Ryan Campbell, CPA, CGMA, CVA describes the sticking point of working capital adjustments and how those affect M&A negotiations.
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If you prefer to read this content, the video transcript is below.
One major issue we come across in the merger and acquisition and valuation world is relating to the working capital adjustments. Now, what is working capital? It’s essentially current assets minus current liabilities, or cash and accounts receivable minus payables and accrued expenses.
Now, why is that important? Well, in an evaluation, we typically are looking at a company’s future cash flow’s potential, or EBITDA, is generally what we look at there. Now in that methodology, we’re making the assumption that the company has an optimal working capital level to sustain operations without a major influx of cash or without having any excess cash there that’s not used in those operations.
Now, when you get to a merger and acquisition situation, the value of the company under the same assumption is that working capital is at an optimal level. So, after we agree upon a price, there is typically an agreement on what the target working capital is that is agreed upon at the time of the sale.
A lot of times, there will be an estimated target working capital and then after about 30 to 60 days, you’re going to then come back and calculate what the working capital actually was and there will be an adjustment either up or down, additional cash to the seller or payments back to the buyer based on that difference of target and actual working capital.
Now, this can be done as a distribution, or it could be taken right before the sale. However, the downside to that is now the future company is going to have to have an immediate influx of capital. So, the seller is not going to be happy with that. Or the cash gets retained in the company and then this adjustment is made, and as I mentioned, paid out after a term of 30, 60 or 90 days after the closing of the deal.
Now, this working capital adjustment is a very common paragraph within a merger and acquisition document.
If you have any questions at all about that, please feel free to reach out to myself or our team and we’d be happy to walk you through and discuss options within the working capital adjustment.