Best Approach for Structuring Working Capital in Acquisitions?

October 28, 2024

by a searcher in Kelowna, BC, Canada

Assume a typical 20:10:70 (Equity, VTB, Senior Debt) acquisition: What’s the optimal approach to structuring Working Capital (Net of AR - AP) and inventory in an acquisition?

Option A: Fold WC into the purchase price, splitting it across equity, a seller note, and senior debt. This requires more equity upfront but retains cash in the business as AR is collected, possibly reducing the need for a large Line of Credit.

Option B: Keep WC separate, financing the share/asset purchase independently, and set up a short-term seller note for WC with potential protections against bad debt. Here, a Line of Credit (margined on AR) could cover WC needs, lowering upfront equity and helping manage bad debt risk.

Are there other commonly used structures? Any approaches banks tend to prefer?

0 Likes

10 Replies

106 Views

Replies

Reply by a professional
from Bentley College in Miami, FL, USA

Inventory Financing:
Some acquirers use inventory-specific financing in addition to AR-based lines of credit. Inventory loans are often structured with a borrowing base tied to a percentage of the inventory value, giving flexibility for WC without eating into equity.

Seasonal or Revolving LoC:
For businesses with cyclical cash flows, a seasonal or flexible revolver can give room to meet WC needs during peak periods. This reduces the need for significant upfront cash and is usually favored by senior lenders for predictable cash flow businesses.

Delayed Draw Term Loan:
Some deals utilize delayed draw term loans, allowing the acquirer to draw WC needs as they arise over time rather than taking it upfront. This keeps debt service low initially and aligns funding more closely with WC cycles.

Bank Preferences

Simplicity & Liquidity:
Banks often prefer folding WC into the transaction (Option A), as it simplifies the capital stack and ensures the business has initial liquidity. This is particularly true for stable or predictable cash flow businesses.

Separate WC Facilities:
Banks may recommend a separate LoC or revolver (aligned with Option B) if they view the business as having volatile cash flows, high AR turnover, or inventory needs that fluctuate.

Reply by an investor
from The University of Chicago in Chicago, IL, USA

In a transaction, the acquirer is not i.) purchasing the business and ii.) separately purchasing NWC. The assets acquired should include all necessary to continue the demonstrated economic performance of the target - and thus, NWC is both an expected and required component of the transaction. As such, it is typically financed within the overall capital structure with many of the concepts articulated by Roman embodied as loan convenants / elements within a commitment from a singular lender. Other considerations to keep in mind - by definition, the transaction should be cash-free, debt-free but that does not prevent an acquirer from stipulating that a certain level of cash needs to be left in the business; it is a matter of negotiation. Also if the target has taken customer deposits, the seller needs to leave cash in the business to the extent that said deposits were not spent on related WIP inventory for the order. The acquirer should expect to receive ownership of all AR but AR > 90 days should be not be valued and AR contract retention should only be valued upon collection with a post-closing pymt to the seller.

+8 more replies.

Join the discussion