Working capital is a figure commonly used in M&A proceedings and is often defined as the sum of a business’s current assets (that are easily converted into cash or equivalents) minus their current liabilities. This figure is used in order to protect buyers from any capital earning discrepancies that may arise during the M&A process.
Due to the lengthy nature of M&A deals, much is likely to change in the time between the LOI (Letter of Intent) and the deal’s closing date. This is why many buyers choose to incorporate working capital adjustments into the agreement; in order to safeguard themselves against possible decline during this time period. Working capital adjustments also help account for new findings in due diligence, as well as any incongruity between the calculated capital and the actual observed capital needed to run the business post-closing. During the M&A process, the buyer and seller agree on a working capital target number. Depending on whether or not the final working capital figure is higher or lower than the target, the seller may receive a bonus or a deduction from the purchase price. The purchase price adjustment typically goes into effect at closing or up to ninety days after the closing of the deal. This is often referred to as the closing adjustment, with a number of provisions, one of which includes the working capital adjustment. These adjustments are the most common post-closing price adjustments made in M&A.
Buyers find working capital adjustments critical for ensuring that the acquired business will continue to be supported by the set amount of working capital. In order to avoid buyers having to generate extra capital for the management of the business after the closing, capital adjustments are made so that the seller is the one who covers the costs of operation.
Unfortunately, working capital calculations are somewhat subjective; therefore, there may be some discretion over the final figures. Different companies are known to measure assets differently, so the working capital measurement must be agreed upon by both the buyer and the seller. Sometimes the parties will run into controversy over whether or not the working capital has met or exceeded the target. In this instance, it is important to have an M&A advisor that can help resolve this issue.
If you would like to learn more about how working capital may affect your current or future M&A transactions, please contact George & Company. We are one of the premier M&A firms in New England and would be happy to speak with you in complete confidence.