Working Capital PEG
June 20, 2021
by a searcher from The University of Chicago - Booth School of Business in Carmel, IN, USA
Hi All,
I recently put in a LOI with seller who verbally accepted to the terms but once it came time to put pen to paper backed out. Issue was with working capital target. I basically said that during diligence we would get a more clear understanding of net working capital required and then set a target for close based on historical needs. The seller wanted to provide me A/R on a loan that would be paid back over the course of a year. I dont have a PE background but always assumed this was generally included. So my question is: What is common for smaller businesses in the 600K to $1.2M SDE range? Is net working capital left out of the deal altogether and buyer brings whatever is needed at close? Or do you sometimes see net working capital included in the deal at this smaller size?
Thanks!
from The University of Chicago in Chicago, IL, USA
2) A buyer who use multiples to arrive P risks loosing the deal for underpaying or risks overpaying w/o realizing. Market multiples have a lot of noise and standard deviation is high b/c inclusion/exclusion of WC is inconsistent.
3) A buyer should run pro-forma financials and calculate IRR to determine P. Then, decide whether to offer P to seller (including WC) or offer P-WC to seller. I get stunned, and frankly frustrated, when a buyer with MBA takes a short-cut and avoids analysis.
4) There no reasonable SDE amount that one can say market-multiple derived price incudes or excluded WC.
5) A buyer is at significant risk by letting seller keep A/R (whole another discussion).
6) Ryan Nelson: Seller is willing to finance A/R for one year. Odds are that you will not have cash flow to repay it in one year. Example: Assume EBITDA = 15% and A/R = 12%. Even if you do not have no debt and CapX = 0, how would you find after-tax A/R of 12% with pre-tax EBITDA of 15%. Of course there are ways to overcome this. (I got a call from a CPA few days ago on a Chicago deal that sounded very similar. CPA was more focused on growth and could not understand the cash flow problem of letting the seller keep the A/R even under 0% growth). Feel free to DM. I am U of C grad, pre-Booth.
from The University of Michigan in Bonita Springs, FL, USA