Working capital peg dynamics at the close of a stock purchase?

August 24, 2021

by a searcher in Berkeley, CA, USA

Fellow Searchers, I am well into the due diligence process for a stock purchase and the sellers and I have come to an agreement about a working capital peg and the close is in a few weeks.

This will be my first acquisition, so I am requesting pointers to reading materials on how the details work at closing - the nitty gritty of how the true up works post close, who gets paid the profits between signing of the agreement and the receipt of cash etc. I see a lot of articles about how to determine the peg and not as much about the sequence of things that take place in the handful of days pre and post close.

Thank you!

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Reply by a searcher
from University of Pennsylvania in Dubai - United Arab Emirates

An approach we have used in the past is to (a) split working capital from cash and (b) to use language such as "normalized working capital" and "minimum cash balance". The reason for (a) is to simplify the discussion about the key WC items namely AR, AP & Inventory and separate it from cash in the business as we have no interest in paying cash for cash. In terms of the WC items we always cleaned up long dated AR and Inv and then looked at historical days of sales or cogs to understand seasonality and normal levels. this approach makes it difficult for the seller to manipulate WC by speeding collections and delaying payables. In terms of minimum cash in the business we look at the historical monthly cash outflows for the company and then factor in any seasonality or "spikes" such as annual insurance premiums or other large items that are upcoming. ^redacted‌ post above references a very useful article that describes an almost analogous approach. you will benefit from reading it

Reply by an intermediary
from The University of Michigan in Bonita Springs, FL, USA

Not sure there is much written on this subject. "The sellers and I have come to an agreement about a working capital peg", I understand this to mean you've come to agreement on a number, but not a post closing process and you are looking for advice on how to negotiate an agreement on how to handle any over/under situation? I assume you have hired a securities attorney for assistance in negotiating your purchase agreement? Your attorney should be guiding you, but there are concepts I've used to help limit the damage to either party post closing: 1) negotiate a band, e.g., plus or minus $25,000 were no adjustment will be necessary. 2) negotiate an upper limit, e.g., plus $100,000 to maximize your exposure to an unexpected overage that will require you to come out of pocket far more than anticipated because of a wild swing to the seller's favor in WC. Overrages should be handled in the form of a note to help the buyer conserve cash at closing. Underrages should be handled in the form of a credit back to buyer at closing, i.e., a reduction in price.

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