Working Capital Peg for an unusual transaction - how to go about it?
December 16, 2020
by a searcher from The University of North Carolina at Chapel Hill - Kenan-Flagler Business School in Toronto, ON, Canada
Hi everybody, I am reviewing a potential deal with the following profile. The question is, how to deal with NWC Peg in these circumstances?
TTM Revenue - $6M
TTM EBITDA - $0.6M
TTM Current assets (A/R + Inventory, excluding cash) - $3.2M
TTM Current liabilities (A/P and other current liabilities) - $0.8M
TTM Cash: $0.2M
Now, working capital is current assets - current liabilities = $2.4M per above example.
Assume valuation at 4x multiple - $2.4M.
As you can see, the TTM WC is equal to the Enterprise Value! How to deal with the NWC Peg in this unusual situation??
from The University of Chicago in Chicago, IL, USA
- AR should be limited to o/s less than 90 days (typically) and exclude retention AR, if any.=
- Make sure customers deposits are not netted against AR - s/b reflected separately as a current liab.
- Value of customer deposits should be left by seller in cash (if so, excluded from computation)
- Need to factor in slow moving and obsolete inventory in the definition of qualified inventory
- Inventory amount should include on balance sheet values only
- Other current assets should only include those of future benefit to buyer (example - asset purchase with new insurance policies < if so, excluded prepaid insurance).
- Current assets excluded from the computation, most likely, will be assets excluded from the transaction
- Current liabilities should exclude all stale items
= Need to understand vacation pay and if target allows employees to "bank" vacation pay year to year (if so exclude - seller to extinguish at closing)
- Benefit plan liabilities should only be included if benefit plans continue forward
- Target is typically preceding 12 month avg. / 3 or 6 months less frequent and based on unique circumstances (heavy recent growth, etc.)
- For fairness (both sides) - every item in the closing day determination should be included in the determination of the target (more difficult than it sounds / example: what was the value of slow moving inventory at month end for each of the past 12 months?
- LOI needs to have a precise definition AND an exhibit of the computation / the exhibit should include date-specific amounts that link back to a historical BS for later reference if necessary
I would encourage all buyers to spend as much time on this as necessary pre-close. It's a sink hole that wastes huge amounts of time during contract negotiations and a potential death knell if the seller does not understand how it works until the very end. Same as Jeff - contact me if you would like to discuss further.
from University of Alberta in Calgary, AB, Canada