Negotiating Net Working Capital Adjustments in M&A - Definitions and How to Calculate
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- เผยแพร่เมื่อ 5 มิ.ย. 2024
- What is net working capital (NWC) and why are adjustments required in an M&A transaction? How do you determine the average working capital required for a business? If a business is declining or growing quickly, what are the best methods to calculate a working capital target? How do you negotiate a fair working capital adjustment? At what stage of the process do you begin to negotiate and analyze working capital trends?
In todays’ video we will review the high level definitions of net working capital and understand the process of calculating net working capital using a formulaic and process-oriented approach best suited for small and mid-market businesses. We will also walk through two case studies and discuss the M&A process and timing in terms of when to begin negotiations.
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Roblee Capital is a Toronto-based M&A Investment Bank focused on serving companies with revenues between $1MM to $100MM primarily offering sell and buy-side M&A services. We work with Canadian-based business owners looking to sell their lower mid-market business. If you are a Canadian business owner looking to sell or buy, please reach out so we can connect at the link below:
www.robleecapital.ca/
One of the best WC overviews. Thanks for sharing.
Extremely beneficial , Thanks
Glad it was helpful!
Hi! Some questions come to mind: what would you calculate a WC peg if the target company is growing quickly then? WC needs will increase over time actually.
In the case of tech/software, would you include or exclude DRs from the WC target calculations? (seller would rather include DRs) from the buyers perspective would it make sense to include short term DRs and exclude long term ones? (say there are 2 cases: cash has been collected for short term DRs but not for long term DRs and the 2nd case: cash has been collected for both short and long term DRs)
Thank you so much for this detailed explanation. My question is with regards to the NWC/TTM analysis you spoke about, I am trying to see the rationale of this analysis, not really clear on this. Also when looking at working capital, could you explain where the assumption of cash requirement/financing by the buyer may come in. Is it some sort of analysis that is also important. Especially for months where we have heavy swings for some months above the Target NWC.
Thank you Sir this is helpful
Thanks for watching!
What if you have not so accurate inventory taken at the offer state. Then more accurate at the close?
Great Video made. One question here couldn't get my head around, at 11:00 for Net working capital target, don't quite understand why if the actual working capital after 60 or 90days is greater than the target, seller get the excess. My understanding is that the higher the working capital, then more funds needed to fund the day to day operation of the business. If actual working capital is greater than target, then required more capital to fund the business, then it should be a bad thing from the buyer's prospective, then how come the seller get the excess cash here? Thanks
The NWC Target is a negotiation, essentially the buyer and seller are agreeing to a fixed number of how much working capital should be left behind on the day of closing. However businesses fluctuate day-to-day (a big order goes out, inventory is bought, etc), because of this there is often a difference between target to actual which has to be paid over to the other party.
Good video, and explanation on contentious items and min NWC etc structures. Had a few clients also w disagreement on deferred income but never heard the the sellside argument of the seller has done the marketing and secured the customer and should get consideration as a result; I imagine the value for this would largely be reflected into purchase price for a business with contractual revenues and deposits?
Good question, its a slippery slope to argue that it would be reflected in the purchase price. If you argue that specific costs need to be covered by holding back the deposit, then it becomes a cost discussion and therefore the seller has a right to also claim certain costs have already been incurred to generate this deferred income, its a two way street. If its part of the purchase price discussion, the seller could argue that this was generated by them and therefore its their funds under their ownership period, you are paying for the future deferred income which will be generated and are not entitled to the current period so why hold back anything (this argument holds less weight and I have not seen it successfully implemented). Its a tough one for sure! Thanks for watching.
Great video! How do you navigate this for a retail business that doesn't have A/R and is seasonal (say majority of profit is achieved 6 out of 12 months)?
Good question, in a seasonal business, its important to review the historical ramp up/ramp down in the net working capital of the business, then based on the closing date of the purchase you set the working capital peg. Taking a multi-year average does not make sense with seasonal businesses, you need to make the adjustment based on the timing of the close. In general, these businesses actually require some sort of cash to finance the ramp up in seasonality so on closing you either negotiate that the seller leaves behind some cash to finance the expected working capital or lower the purchase price by the cash the buyer needs to inject into the business. Thanks for watching!
I'm a bit confused about something, at 35:00 you mention that if you were the buyer, you'd want your target to be higher - but I'm not sure why. Based on everything you've talked about a higher NWC target would cause a buyer to pay out more, meaning buyers should want a lower target and sellers would want a higher one.
Is this more about surprises? IE: Buyer wants a higher target because this way the seller has smaller chance of surpassing it and causing the buyer to give an unintended extra payment to cover that?
Thanks!
Good question, as a buyer there is a natural inclination to push for a higher target NWC (regardless of the scenario) as they would benefit from assuming more NWC without having to pay for it. NWC ultimately is real money that will get collected over 30-90 days as AR accounts are settled and cash comes into the business, as I buyer I want to receive more AR on my starting balance sheet! And yes it reduces your chances of having to pay a higher purchase price adjustment if actual closing NWC comes in higher than expected which can be a burden for the buyer who may need to invest more cash to cover this working capital adjustment. For a seller, the principle is reverse, I have worked hard to generate the AR on my balance sheet, why should I give up these incoming cash proceeds without payment to the buyer? Sellers always have a tough time accepting this and there is a natural tug of war that exists between the two sides because of this. Hopefully this helps!
@@financekid3163 Thanks, that makes a lot of sense!
What about if you close towards the end of the month and there is no cash in the bank to cover off employee wages or paying suppliers? Then there will need to be a portion of cash / equity put into the business, the value of which would essentially be increasing the purchase price. Sometimes this level of cash can be significant, I have seen up to 25% of total purchase price.
This is a good question and there is no single answer. In most instances buyers will capitalize the balance sheet with either some float money or have an operating line/credit card in place to finance the interim expenses during the first month. The bank that you finance the acquisition with will usually provide this operating line as well. Wages would be pro-rated based on the timing of the close with the seller being responsible for their share. Suppliers in most instances have payment terms, similarly customers have payment terms as well so there is a steady inflow/outflow of expenses. I have not seen any transaction have 25% cash as part of the purchase price, probably this is for small business transactions. In some instances the seller leaves behind cash for 30-90 days while the business is transitioned and as part of the working capital true up, they recoup this cash from the buyer who now has transitioned the day-to-day operating expenses. Hopefully this helps.
Can wen have this file?
Sorry the files are not available. Thanks for watching!
Why is it advantageous to do a cash free debt free basis acquisition? I don't understand why "buying cash" on the balance sheet is bad from a tax perspective?
Good question. Think of it this way. If you are buying a $1MM company with $500K in cash, how much in debt vs equity will you need to close the deal? Why not just pay $500K for the equity value excluding cash and bring your own cash to the balance sheet? By buying the sellers cash, you are allowing them to move that cash off their corporation's balance sheet at a more effective tax rate compared to if they had to dividend out the cash personally to themselves at an investment income tax rate. Its actually tax advantageous to the seller to sell their cash but less so from the buyers point of view as they have to incur fees on paying a higher purchase price so net net its a loss for the buyer.