Did You Know…
If you are entering into an M&A transaction, chances are you’ll hear a lot about “working capital”?
by Joseph Ramadei
Simply put, working capital is the capital that is used to operate the business on a day-to-day basis. In an M&A transaction, a buyer typically demands that the seller leave behind some amount of Working Capital, so that the buyer will be able to seamlessly operate the business after closing without an immediate need for a capital infusion. As a result, the two sides will agree on a Working Capital “target.” On the most basic level, Working Capital equates to the current assets of a business (less cash), minus its current liabilities (less borrowed debt).
Typically, at closing, the seller will estimate the Working Capital of the business as of the closing date. The purchase price will then be adjusted dollar-for-dollar based on this calculation, upward if the estimate is greater than the target, and downward if the estimate is less than the target. Within a certain period after closing, the buyer will calculate what the actual Working Capital was on the closing date, and the purchase price will be further adjusted depending on whether this amount was higher or lower than the estimate.
For M&A deals, buyers push for higher targets, which has the effect of reducing the purchase price, while sellers aim for lower targets, and the target is often tied to the historical practices of the business. Both sides will spend a fair amount of time negotiating and finalizing what is to be included in “current assets” and “current liabilities” when determining the definition of “Working Capital.”
Understanding the basic concept of how Working Capital impacts a transaction is important for buyers and sellers, and having counsel to shepherd the parties through the nuanced details that arise is just as crucial!
