Incorporating Working Capital & A/R into an LOI
October 21, 2024
by a searcher from University of Alaska Anchorage - College of Business and Public Policy in Vancouver, WA, USA
Good Morning,
Currently looking into purchasing a firm that deals in B2B projects in a specialized industry. Target has 35+ years of experience in one major geographic location with a fantastic team of professionals who excel in what they do. Tenure of the employees is on average long with low turnover. Highly compensated individuals.
We are looking to submit an LOI which includes cash from the seller for Working capital and some sort of mechanism for ensuring A/R is received to add to the pot of WC. Does anyone have any examples of how this is done and how it affects the ask price?
from James Madison University in Washington, DC, USA
How to Calculate the Working Capital PEG in M&A Deals:
1. Working Capital PEG Calculation: Working capital PEG is used to ensure a business has enough working capital to maintain operations post-acquisition.
Here’s how to calculate it: Steps: Identify Core Components: Working capital = Current Assets - Current Liabilities
Focus on: Accounts Receivable (AR) Inventory Accounts Payable (AP) Clean Historical Data: Review historical data (typically over###-###-#### months) and exclude non-operating or one-time items, such as one-off sales or expenses that don’t reflect normal business operations.
Calculate Average Working Capital: Calculate the monthly average of working capital over a representative period, usually the trailing 12 months (T12).
This average is often used as the baseline for negotiations.
Average Working Capital = Sum of Monthly Working Capital over Period Number of Months Average Working Capital= Number of Months Sum of Monthly Working Capital over Period Adjust for Seasonality (if applicable): If the business is seasonal, ensure that your average reflects the business’s normal operating cycle during its peak and off-peak seasons.
Set the Working Capital Target: Once adjustments have been made, this average becomes the “PEG” or target working capital, which the business should meet at the time of closing.
Lookback Period: After the deal closes, a working capital review (lookback) is typically conducted 60 days post-closing to ensure any differences between the actual working capital and the target are captured. This allows for a more accurate reflection of the working capital situation after the business transition.
Post-Closing Adjustments: If the actual working capital at closing is below or above the agreed-upon target PEG, a post-closing adjustment is made between the buyer and seller. This adjustment compensates either party based on the deviation from the target, ensuring a fair settlement in line with the negotiated terms.
Hope this helps. Learn more here https://oconnelladvisorygroup.com/contact/
from University of Michigan in Detroit, MI, USA
The normalized working capital at the closing of the Transaction will be calculated according to the business’s accounting principles, consistently applied. The Purchase Price payable at closing will be increased or decreased based on the difference between the normalized and actual working capital of the business at the closing.
Note, instead of buying cash with cash (taking out a loan to purchase the target's cash), your lender may just extend you a LOC, and you could make the acquisition cash-free.
Let me know if you want to discuss further. Feel free to DM me here or reach out directly at redacted