Working Capital Not Included

August 08, 2024

by a searcher from University of California, Santa Barbara in Toronto, ON, Canada

I'm seeing a lot of brokered deals that specifically say that working capital or inventory and receivables are not included. What's up with that?
How do you deal with this? Is it just a matter of adjustment to the price and you'll work it out at the negotiating table or it's something more important to you?

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Reply by an intermediary
from Wake Forest University in Winston-Salem, NC, USA

This reminds me of a prior post. The answer is that the percentage of transaction where NWC (specifically AR -AP) is included and excluded from the Price of a transaction varies greatly by size. Based on a rolling 4 Quarter Average of the last four Quarterly M&A Source/IBBA Market Pulse reports, in transactions <$2 mm only 24% included NWC, $2 to $5 mm is 39%, and $5 - $50 mm it was included 69% of the time. The key is to be clear when you are calculating value as to what components of NWC (inventory, AR, AP, prepaids, deposits, etc.) are included and excluded from the Price you came up with. After that, it is the old math property A + B = C, thus C - B = A. When NWC (B) is included in the price (C) the buyer is funding NWC through the acquisition loan. When NWC (B) (particularly AR/AP) is not included in the price (A) or the transaction, then the buyer is funding it with a permanent WC loan and/or LOC (lenders provide these regularly alongside the acquisition loan). When using multiples to determine if the price you are going to offer includes or excludes NWC, users must be aware of the NWC rules of the database. For example, PeerComps includes inventory but excludes AR/AP. DealStats is all over the board and you have to look at the detailed data set (all 199 columns) to determine if your comps include or exclude NWC (in a recent pull I did of 39 manufacturers, only 3 of the 39 included NWC in the calculation). So, just like you wouldn't apply an SDE multiple to EBITDA, you wouldn't apply a multiple that excluded NWC to come up with a price that included it without adding the NWC value to it. A + B = C, thus C - B = A.

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

Price (P) of a business to a buyer is its total cost of acquisition. Such price P should include all assets including WC. Whether the broker's ask includes or excludes WC is irrelevant. Whether a business needs WC or not depends on the type of business and the business model, not on its size. (See example below)

It is common to use databases of market multiples. The definition of "price" in the databases is the "consideration" paid to the seller; it is not necessarily the Price (P) from a buyer's perspective. Further, each database is different with respect to what is included in their definition of "price" or "consideration" paid to the seller.

Buyer has the option of determining the Price (P) they can afford to pay by running financials. Such financials will include not only WC but also CapX. Then the buyer has the option of offering P (adjusted as needed) that includes WC. or making an offer of P-WC after estimating the WC need of the business.

I can go for hours on this subject. What is WC? How do you calculate it? How does accounting impact it? How do you adjust for seasonality? And, more.

In a recent class at IBBA/M&A Source I used following example:
X and Y each own a retail store selling apples. X sells to walk-in customers. Y sells to restaurants, and even delivers. Both buy apples from the same vendor and pay cash. Hence, no AP. Both make same profit. Y sales are more b/c of volume discount. Y has more inventory to support restaurant customers and has A/R.
If X sells for P, what should a buyer pay for Y? If growth is 100% growth, who will have higher cash flow?

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