Scarinci Hollenbeck, LLC
The Firm
201-896-4100 info@sh-law.comFirm Insights
Author: Scarinci Hollenbeck, LLC
Date: January 22, 2018
The Firm
201-896-4100 info@sh-law.comGiven that working capital adjustments are very common in merger and acquisition transactions, it is important to understand how they work and how they could impact your deals. In basic terms, working capital is the difference between current assets and current liabilities. Of course, it’s never that simple, and M&A purchase agreements typically address the components of working capital that will be included and excluded from the deal. For instance, many M&A agreements exclude cash and long-term debt. Others may exclude certain liabilities, such as income taxes.
Sellers are typically expected to deliver a certain amount of working capital when selling a business. That is because working capital reflects the current ongoing business activity of the business. The purpose of a working capital target is to set a level of working capital that the buyer and seller agree should be included. It is, ultimately, a negotiated number based on a variety of factors, and is traditionally thought of as an adjustment to purchase price. A higher target effectively reduces the purchase price while a lower target effectively increases the purchase price.
The requirement of sufficient working capital to fund ongoing operations is often first addressed in the letter of intent. As the negotiations proceed and the seller furnishes relevant due diligence, the target, and mechanism for calculating working capital, is further negotiated. For example, a deal might include a purchase price of $60 million and require the seller’s delivery of $10 million of working capital at closing.
Sellers with excess working capital can typically distribute it prior to closing, or, if not able to do so, can either receive an adjustment at closing or in a post-closing true-up process. Sellers with a working capital deficiency either have the purchase price reduced or a correction in the true-up process.
Working capital targets are generally determined by looking at the average monthly adjusted working capital over a defined period. The most appropriate method for determining working capital can vary from industry to industry and business to business. One common variation is an adjustment reflecting seasonality in a seller’s working capital. This occurs when a company’s sales vary significantly from season to season. In addition, businesses that provide products or services prior to receiving payment may also operate with negative working capital, which must also be considered when negotiating an acquisition.
Below are several key issues that should be considered when negotiating a working capital target:
In addition to determining a working capital target, the purchase agreement must determine how it will be calculated, i.e. generally accepted accounting principles (GAAP). It must also establish a dispute resolution mechanism should the parties be unable to reach a final figure after the closing.
During the M&A due diligence process, the buyer frequently identifies issues that may require adjustments to the initial target. Negotiations can be difficult because provisions that favor the buyer are typically unfavorable for the seller. For instance, the seller would prefer to have no working capital adjustment at all. While the buyer would want the agreement to allow only a downward adjustment. To resolve such impasses, agreements sometimes define working capital as a permissible range or establish a basket where working capital is only adjusted if it is a specific amount above or below the target.
In many M&A transactions, the buyer recalculates the working capital adjustment after the transaction closes in a true-up process. The true-up adjustment is typically made on a dollar-for-dollar basis. For instance, if the target is set at $10 million and the seller delivers only $8.5 million of working capital, the purchase price would be adjusted downward by $1.5 million.
If the seller does not agree on the buyer’s true-up calculation, additional negotiations may be needed. If a deal can’t be reached, the parties may employ the dispute resolution process set forth in the agreement.
Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Jeffrey Cassin, at 201-806-3364.
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Corporate transactions can have significant implications for a corporation and its stakeholders. For deals to be successful, companies must act strategically to maximize value and minimize risk. It is also important to fully understand the legal and financial ramifications of corporate transactions, both in the near and long term. Understanding Corporate Transactions The term “corporate […]
Author: Dan Brecher
Ongoing economic uncertainty is forcing many companies to make tough decisions, which includes lowering staff levels. The legal landscape on both the state and federal level also continues to evolve, especially with significant changes to the priorities of the Equal Employment Opportunity Commission (“EEOC”) under the Trump Administration. Terminating an employee is one of the […]
Author: Angela A. Turiano
While filing annual reports may seem like a nuisance, failing to do so can have significant ramifications. These include fines, reputational harm, and interruption of your business operations. In basic terms, “admin dissolution for annual report” means that a company is dissolved by the government. This happens because it failed to submit its annual report […]
Author: Dan Brecher
Antitrust laws are designed to ensure that businesses compete fairly. There are three federal antitrust laws that businesses must navigate. These include the Sherman Act, the Federal Trade Commission Act, and the Clayton Act. States also have their own antitrust regimes. These may vary from federal regulations. Understanding antitrust litigation helps businesses navigate these complex […]
Author: Robert E. Levy
If you’re considering closing your business, it’s crucial to understand that simply shutting your doors does not end your legal obligations. Unless you formally dissolve your business, it continues to exist in the eyes of the law—leaving you exposed to ongoing liabilities such as taxes, compliance violations, and potential lawsuits. Dissolving a business can seem […]
Author: Christopher D. Warren
Contrary to what many people think, corporate restructuring isn’t all doom and gloom. Revamping a company’s organizational structure, corporate hierarchy, or operations procedures can help keep your business competitive. This is particularly true during challenging times. Corporate restructuring plays a critical role in modern business strategy. It helps companies adapt quickly to market changes. Following […]
Author: Dan Brecher
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!