The Role of Net Working Capital Target in Cash-Free/Debt-Free Deals
In the complex world of mergers and acquisitions (M&A), one term that often takes center stage is “net working capital target.” This seemingly technical phrase holds immense importance, especially in cash-free/debt-free M&A transactions. In this article, I’ll delve into the significance of net working capital target and break down its definitions and individual components, including one of the key players, “accrued expenses.” Let’s explore this financial puzzle together.
NET WORKING CAPITAL TARGET
In an M&A deal, net working capital target essentially represents the working capital that the buyer expects to see when they take over the acquired business. It’s a fundamental concept that ensures a smooth transition and sets the stage for a fair transaction. To understand its importance, let’s dissect its definition and the components that make it up.
DEFINING NET WORKING CAPITAL TARGET
The net working capital target is the agreed-upon working capital level at which the buyer takes control of the business. It’s crucial because it determines the amount of cash and debt that will be transferred during the deal. In a cash-free/debt-free M&A transaction, the purchase price is typically adjusted based on the variance between the actual networking capital at closing and the net working capital target.
COMPONENTS OF NET WORKING CAPITAL TARGET
Now, let’s break down the key components that makeup net working capital target:
Current Assets: These are the assets that can be easily converted into cash within a year, such as accounts receivable, inventory, and cash itself. The net working capital target typically includes a specific level of current assets.
Current Liabilities: These represent the obligations that need to be settled within a year, including accounts payable and accrued expenses. Managing these liabilities is where accrued expenses come into play.
ACCRUED EXPENSES
Accrued expenses are the obligations a company incurs but hasn’t paid for yet. These can include salaries, bonuses, and various other liabilities that have been accrued, but not yet settled. In an M&A transaction, these accrued expenses are carefully examined, as they can significantly impact the deal.
THE “TRUE-UP” TYPICALLY WITHIN 90 DAYS OF CLOSE
In a cash-free/debt-free M&A transaction, adjustments are made within a certain timeframe, typically within 90 days of the deal closing. This is where the “true-up” comes into play. The true-up process involves reconciling the actual financial position of the business with the originally agreed net working capital target.
For example, for sake of simple math, let’s say the net working capital target was set at $100,000. However, due to various inputs up to the closing date, the actual net working capital delivered by the seller is now $200,000. In this case, the seller would receive an additional $100,000 as a result of the true-up. The inverse is true as well; if the actual net working capital is lower than the target, the seller may need to compensate the buyer for the difference.
The true-up process ensures that neither the buyer nor the seller unfairly profits or loses out due to these adjustments. It maintains the financial fairness and accuracy of the deal, aligning it with the initial expectations set during negotiations.
Net working capital target and its components, such as accrued expenses, play a pivotal role in cash-free/debt-free M&A transactions. Additionally, the true-up process within 90 days of closing ensures that the deal remains fair and transparent. Meticulous financial management and a thorough understanding of these concepts are vital for a successful M&A transaction. So, as you navigate the intricate world of M&A, remember the significance of net working capital target, the true-up process, and how they ensure that both buyer and seller benefit equitably from the transaction.
There are many things a seller can do well in advance of a deal to improve their working capital position to therefore to keep more cash in a cash free debt free transaction. Contact for some of the ways you can save thousands to millions depending on the size of your company in a transaction.
By Craig Dickens, CDI Global Partner
