Working Capital in LOI? - Searchfunder

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by a searcher from The University of Georgia - Terry College of Business
in Denver, CO, USA

10mos ago

Working Capital in LOI?

Hello! First time poster and preparing to present an LOI this week for a distribution business. I have a few questions as we're structuring the offer in regards to working capital: - How do you calculate the right amount of working capital to request in the LOI for a smooth first 90 days? - Do most deals you’ve seen include a working capital peg or target in the LOI? If so, how is it determined? - How do you define “normalized” working capital, and what adjustments do you push for before closing?

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reply by a searcher 10mos ago
from New York University in San Diego, CA, USA

Here's the exact WC verbaige I used in my LOI yesterday (obviously your peg will change based on the business). Definitely don't wait until exclusivity to discuss it with the seller- that's a great way to kill the deal and waste time. a) Peg. Normalized net working capital ("NWC") at closing shall be $5,000,000, calculated as current assets (excluding cash and income tax assets) minus current liabilities (excluding funded debt and income tax liabilities). b) Methodology. A/R >90 days past due will be valued at 50% for peg purposes unless specifically agreed. Unbilled receivables to be included only to the extent billable under existing contracts. c) True-Up. Dollar‑for‑dollar purchase price adjustment for variance from the peg, with a 90‑day post‑close determination period and customary dispute resolution mechanics.

reply by a searcher 10mos ago
from IMD in Orlando, FL, USA

Buyers usually look at historical working capital levels (often average month-end WC over the last 12 months, sometimes longer) to see what’s truly required to “run the business as-is.” Look at: Receivables cycle: How long until you collect sales? Payables terms: How quickly do you have to pay suppliers? Inventory turns: How much inventory is normally required? Take the average net working capital (current assets – current liabilities, excluding cash and debt) over the last 12 months, and stress test it against seasonality. That’s usually a reasonable peg to ensure you’re not short. Most professionally structured deals reference a working capital target (the “peg”), even at LOI stage. In the LOI, it’s often drafted at a high level, such as: “The purchase price assumes the company will deliver a normalized level of working capital, consistent with historical operations, at closing. A mutually agreed peg will be established during diligence.” The exact number usually gets set later, during confirmatory diligence, once you’ve had a chance to analyze seasonality and trends more closely. Put a principle-based clause in the LOI (normalized WC consistent with past practice), and leave the exact peg to diligence. During diligence, calculate monthly NWC over the last 12–24 months, adjust for seasonality, and negotiate from there.

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