Avoid Leaving Money on the Table

Key Steps to Simplify M&A Working Capital


Bryan Graiff,
Transaction Advisory Partner,
Brown Smith Wallace

Dan Schoenleber
Transaction Advisory Principal,
Brown Smith Wallace

Working capital is one of the most complex areas of transactions. Other than a rep and warranty claim, it tends to be one of the most contentious post-closing disputes that often requires litigation, or the threat of litigation, to resolve. While working capital is simple to define – current assets less current liabilities – problems can arise from lack of experience. Without proper working capital procedures in a transaction, either side could potentially leave money on the table.

Neither the buyer nor the seller should “come out ahead” as a result of working capital; in order to ensure this happens, most purchase agreements include a working capital target or “peg.” Here are key steps to simplify M&A working capital in a transaction:

  1. Agree on the Working Capital Definition

Buyers typically prefer working capital to be based on GAAP, while sellers prefer it be based on their past practice, whether it fully complies with GAAP or not. Determining what will be included in the working capital calculation is also important. The best way to identify accounts to be included in working capital is to incorporate a schedule in the purchase agreement with a listing of the included accounts and the target calculation.

  1. Calculate the Working Capital Target

A working capital target should not be agreed upon until the buyer has been given adequate time and information to assess the working capital needs of the company. Determining what the target should be is the most difficult piece of the process. Typically, the target is based on a trailing 12-month historical average of the company’s working capital. Often, this is the same period the purchase price is based on and it also averages out the impact of seasonality in a business. Accounts need to be thoroughly reviewed to ensure a trailing 12-month average is a good estimate of the company’s working capital needs. Additional considerations should include:

  • Latest trends in the business
  • Anomalies and non-recurring items in the historical period
  • Aging of receivables and payables, especially timing of payments to vendors
  • Reserves or allowances for accounts receivable and inventory
  • Deferred revenue
  1. Make Sure Both Sides Understand the Closing Date Cash Impact

Cash is king, and it’s what everyone is concerned about at the end of the day. If all parties are not on the same page, something could blow up days before closing.

  1. Verify During Post-Closing True-Up

When a transaction closes, it is just the beginning of working capital calculations. The actual amount of working capital delivered by the seller is not always easy to determine at the closing date, which is why agreements typically allow for a 60-day to 90-day period to finalize these figures. In determining the closing working capital, verify inventory (physical count), accounts receivable, deferred revenue and other significant working capital amounts. This post-closing period is the one opportunity to verify the working capital.

There are many factors to consider when reviewing working capital in any given transaction. In any scenario, it is important to spend the appropriate time in this area and get the right advisors involved to avoid leaving money on the table.

Bryan Graiff has over 25 years of C-level experience and has led over 100 buy and sell-side transactions from both sides of the desk.

Dan Schoenleber leads due diligence and quality of earnings engagements, post-closing working capital and opening balance sheet procedures for M&A clients.