The NOC`s adjustment also reduces the seller`s incentive to manipulate working capital by speeding up debt collection, delaying liabilities and taking other steps to maximise liquidity distributable to the seller before closing. Second, by changing the way working capital is calculated as part of the closing acquisition agreement compared to how working capital has been calculated by the company in the past (and in calculating the target). This could be done in advance by carefully developing and negotiating the working capital definitions and associated accounting principles in the acquisition agreement. Or it can be done on the backend when the buyer prepares the working capital statement after closing. For example, a buyer could adjust working capital amounts (e.B. increase discretionary reserves, etc.), while remaining within the limits of the SPA to obtain a lower amount of final working capital if the acquisition agreement applies broad and flexible accounting policies. Acquisition agreements often include as a basic standard that “working capital closing must be prepared in accordance with GAAP” because GAAP is a well-understood concept. However, GAAP only provides guidelines that are subject to interpretation by a single company. For example, with respect to “value adjustments for doubtful accounts,” GAAP simply states that a company must have a debt reserve that it does not expect, but GAAP does not specify how that reserve is to be calculated. An aggressive buyer might find that the reserve has not been sufficient in the past and increase it in the closing balance sheet, thereby reducing working capital and making a price adjustment in favor of the buyer. Since most (but not all) of the NOC`s adjustment formulas require payment to the seller if the NOC`s closing exceeds the target, the NOC`s adjustment protects the seller against exceptionally positive fluctuations in the NOC that would otherwise give the buyer a chance in the form of excess working capital. This preserves the underlying assumption in most of the United States. M&A treats that the business is operated for the economic benefit of the seller (and at the risk and peril of the seller) until closing.
An important part of a typical merger and acquisition (M&A) transaction for both parties is the topic of net working capital. A simplified definition of net working capital is an entity`s current assets (minus cash) minus its current liabilities (minus liabilities). Or, more simply, the amount of money needed to generate the income a buyer might expect during a cash cycle. This is crucial for an optimal transaction, but is often overlooked by both the seller and the buyer during a merger and acquisition. In smaller transactions, a buyer often does not receive working capital in the transaction – he only receives the assets (without cash) and no liabilities. Then, the buyer must provide the working capital (i.e. the money to convert these assets into profit). However, for larger transactions, buyers almost always want to take over the business with agreed working capital. Conclusion The net amount of working capital offers benefits to both the buyer and seller of a merger and acquisition. However, sometimes it happens that it is not sufficiently taken into account. Doida Law Group has experience in negotiating all parties to M&A transactions, including targeted working capital and possible adjustments.
Fee security is something we offer our customers through our unique billing structure. If you have any further questions about how to get started with us, call 720.306.1001 to get in touch with a member of our team today. The target working capital is often based on the company`s average working capital over the past twelve months. There are two main reasons why a twelve-month average is usually used. The first reason is that an annual average eliminates all the effects of seasonality. Second, the number of EBITDA underlying a buyer`s offer is usually measured over the past twelve months, so it makes sense that there is a match. If a company is growing rapidly and the offerings are based on EBITDA forecasts, the target working capital should ideally be based on the projected average working capital over the same period. Since projected net working capital is often not available, it is common for buyers to apply an expected growth rate of EBITDA to historical working capital when calculating the working capital target. If, in the case of a growing company, forward-looking earnings are taken into account, but historical working capital (with positive working capital) is used to set the target, this target will generally be lower than expected in the future, so that the normal level of working capital set in the price could be artificially low, which will harm the buyer. The parties must take into account, among other things, seasonal fluctuations, unusual or one-off events and the recent growth of the business, which requires a higher level of “normal” working capital. The parties should involve their accountants and financial advisors in discussions on the NOC`s target amount and be prepared to present convincing arguments on the NOC`s target level.
In response, we often see sellers offering very specific and detailed accounting methods for calculating the statement of financial statements, especially working capital. Instead of simply preparing accounting policies “in accordance with GAAP”, sellers will continue to be “consistent with past practices” and will often include a separate investment of specific accounting policies to be used in the preparation of financial statements. These specific accounting policies are sometimes presented in the form of a hierarchy that includes: (1) specifically listed accounting policies; (2) except as expressly in subparagraph 1, all the accounting methods, methods and procedures used for the preparation of the most recent audited financial statements; and (3) to the extent not included in (1) or (2), in accordance with GAAP. In addition, sellers can add a detailed illustrative example of how working capital should be calculated, moving to the detail level of the test balance sheet account to show which accounts should be included. Even though this document can add several pages to an agreement, the establishment of these details allows the seller to exercise significant control over the preparation of the final declaration, even if the buyer is usually the party who actually prepares it. .
