Net Working Capital in an M&A Transaction

Net Working Capital in an M&A Transaction

by Joe Hellman, CPA

The purchase price in an M&A transaction is often thought about as the enterprise value, which is the adjusted EBITDA times a given multiple (that varies across different industries and sectors and is based on growth potential, market share, and competitive landscape); however, there is another important figure that is often forgotten about until the end: net working capital.

Assessing net working capital is a crucial component of financial due diligence, along with a quality earnings report and an analysis of debt and debt-like items. The net working capital number reflects the companyโ€™s overall financial health, and in particular, its liquidity. These are the things that potential buyers want to see, that a seller should be able to speak to.

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As a simple calculation, net working capital is the difference between current assets and current liabilities where the net number can be positive or negative. It sounds easy, then, to arrive at an established number or peg everyone can agree on, but it is not. Nonetheless, developing an accurate, agreed-upon figure provides comfort to both the buyer and seller that there will not be a significant change in the purchase price at close.

Net Working Capital Also Affects Post-Acquisition Performance

One of the most critical issuesโ€“at least from the buyerโ€™s point of viewโ€“is that the new-to-them company has adequate working capital available from day one to carry through at least the initial transfer and/or integration period.

Commonly, private M&A transactions aim for the company to be debt-free and cash-free at close where the seller pays off any current debts and retains any remaining cash. Though this is common practice, there will always be exceptions to the โ€œnormโ€ in these transactions.

If, for some reason, the business has higher than its established target or peg for net working capital at close, a surplus would result in an increase to the purchase price. On the other hand, if net working capital at close is lower than the established target or peg, a shortfall would result in a decrease to the purchase price. This is a very simplified example of how net working capital comes into play. The use of collars and caps to establish a range is not uncommon and can impact the purchase price as well.

The net working capital can be calculated in a variety of ways, and there is often not an inherently right or wrong way in doing so, but having the chosen methodology applied consistently when establishing a target net working capital, and when calculating the true-up post-close, will be instrumental in avoiding disputes. The key to avoiding such disputes is to have the purchase agreement wording aligned with exhibits used during the negotiations between the buyers and the sellers. 

Finding the Right Number

There is no simple or universal formula for calculating net working capital, so this issue can easily become contentious. Many companies do not fully comply with Generally Accepted Accounting Practices (GAAP) and saying that your financial statements and net working capital number is in compliance with GAAP is not enough and may actually harm you as you go through negotiations. There are multiple considerations and multiple potential adjustments that may be made before arriving at a final figure both parties can agree on.

Without both-party agreementโ€“in definition and in numberโ€“to what constitutes indebtedness and net working capital, the deal could fail.

Buyer or seller, you want the M&A process to move forward as smoothly and as advantageously as possible. The sheer complexity of calculating net working capitalโ€“and the potential downside to getting it wrongโ€“underscore the importance of including your M&A advisory team from the beginning. Their expertise and guidance in this and all aspects of financial due diligence can protect your company and help you negotiate the best possible deal.


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Joe Hellman, CPA

Joe Hellman, CPA

Joe Hellman is a partner leading the Transaction Advisory Services practice at Redpath and Company. He provides support to clients throughout the transaction life cycle, from evaluating opportunities pre-LOI to post-close net working capital true-ups and synergy assessments on both buy-side and sell-side transactions. Joe has experience across a variety of industries including manufacturing, healthcare, construction, consumer products, distribution, financial services, and energy. He has provided public accounting services since 2008 and joined Redpath and Company in 2020.