How to negotiate Net Working Capital

January 02, 2022

by a searcher from Emory University - Goizueta Business School in Atlanta, GA, USA

Are there any published standards to refer to when negotiating net working capital with a seller?

I am in negotiations to buy a business and the primary sticking point is net working capital. The seller believes there should be no adjustment, that any capital tied up should be theirs. As a financial buyer, I have modeled and set price based on a multiple assuming normalized working capital will stay with the business. In this particular transaction, the expected net working capital represents ~12% of the sales price.

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Reply by a professional
from Seton Hall University in Morristown, NJ 07960, USA

I agree with most of the posts already here. In my recent dealings, experience mostly agrees with @Bob Champoux, "we simply note that the seller has to provide enough working capital to ensure that the Buyer doesn't have to infuse more cash and thus suffer a de facto price increase after closing".

On the last deal I was involved with, cash flow was awesome but seller was using short-term financing to purchase long term assets. Business was well positioned to cover, so there shouldn't have been a big issue, but the ST financing lopsided the NWC, and the parties made a big deal of it. Overall, I agree with the other comments where people are saying, model it out on your particular facts, it shouldn't be a sticking point, just has to be realistic and fit your circumstances.

Reply by an intermediary
from Northwestern University in Orlando, Florida, USA

If this deal is going to fail, only let it fail for a good reason, not a dumb one related to working capital. Unless it is otherwise stated, you can assume that any asking price or valuation assumes inclusion of what we'll call required working capital. Required working capital is an amount of working capital that, if in place at the time of closing, causes the firm to have a "very low probability" of becoming illiquid in the months following closing, if managed properly, without an additional infusion of cash. Determining required working capital can only be done with a statistical analysis, technically, although you can approximate it casually. Note that required working capital sometimes exceeds actual average working capital. Some owners keep hundreds of thousands of dollars of extra cash in the business for no apparently good reason. If I keep $10m of cash in my business that generate $1m in annual EBITDA and I'm asking $5m for my business, the buyer does not get to keep the $10m in cash. That cash is effectively not part of the business.

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