Setting NWC target after change in terms

November 21, 2024

by a searcher from Harvard University in Cambridge, MA, USA

We have a deal under LOI that is expected to close in December and are at somewhat of an impasse in our NWC target negotiations.

Our QoE report (which used data through to end of September) showed a very consistent level of NWC. However, the sellers claim that in October they availed themselves of longer terms with their vendors, and as a result their payables went up significantly. They are arguing that this represents a "new normal" for the business and that the target should reflect the numbers from October onwards. Obviously this is problematic given that we only have 1.5 months of data to go on (as I'm writing this in mid-November), and the difference between the target using the pre-September and October numbers is very significant (5-10% of the purchase price).

Has anybody encountered this situation before? If so, how have you dealt with it to protect yourselves? Interested in particular in hearing about any clauses or mechanisms in the purchase agreement that could mitigate the risk. (This is an SBA-funded deal, btw. I know sometimes SBA SOPs don't allow certain things that would be acceptable otherwise.)

Reply by a searcher
from The University of Chicago in Los Angeles, CA, USA

Hi Sebastien - Several thoughts:

1) I do think it is worthwhile for you to go look at each of the major vendors and figure out how much time you have to pay major vendors. What are the payment terms in any contracts, purchase agreements, invoices? When is the seller making the payments and how have they been adjusted?

2) Without seeing the numbers, the seller must have done something drastic? Hard to see how paying some vendors in 28 vs 21 days is going to have a material change on the nwc calculation.

3) Agree with the comment that the seller's payments terms might not be yours. Would be important to understand.

4) Think there is a mathematically correct / logical answer here. I would strive to get to that answer rather than working around it through legal language.

5) Having a working capital target set on 1.5 months of activity is highly unusual

6) I don't know what had been agreed to around this topic, but I would be very careful about moving goal posts at this point in the negotiation, as it could allow other goal posts to be moved as well.

Reply by a professional
from Dartmouth College in Los Angeles, CA, USA

Just to clarify, under existing terms closing NWC would be lower than the previously agreed target because they've delayed their payables (thus increasing current liabilities and reducing NWC). Presumably sellers are keeping any cash at closing, so the effect of what they are proposing is allowing them to keep more cash and leave the business with more AP, without a corresponding reduction to the purchase price. Clearly this is a non-starter for you. But not uncommon for sellers to try and take one last bite at the apple right before close. I don't think you need to overreact and question everyone's motives, but you do need to push back. If they don't want to adjust the headline price based on the old target, then they should agree to leave more cash in the business to cover the excess AP. Has to be one or the other. And you're right that SBA lenders do not like any uncertainty around NWC adjustments after close. They need to have certainty around the price and the business. The good thing is that this can give you leverage with the seller to say that your hands are tied

+22 more replies.

Join the discussion