How to set NWC target in M&A for negative NWC business
I am working on a sell-side auction of a private healthcare company, and the target has negative NWC consistently over the last few years. With further business expansion, NWC becomes even more negative as deferred revenue increases.
In your experience, how would both sides typically negotiate the NWC target in such situations? Understood that this is typical for consumer business like those in retail, media, publishing and etc. Thanks very much in advance.
Have seen it a few ways:
Set it at the trailing average (3 month/6 month/12 month) as your normally would. As long as the calculation methodology remains consistent and the buyer knows what he's getting, a negative peg is fine. If they have been expanding rapidly lately, it might be better to set the peg at the 3 month or 6 month average rather than 12. That being said, if the target is declining due to big increases in deferred revenue, that may get removed from adjusted NWC anyway. If I'm a buyer, I'm going to argue that deferred revenue represents cash that the seller received for services that I have to perform and therefore, that cash should be left in the business.
Set the peg at $0 and have the seller leave as much cash as necessary with the business to get to $0. For example, if NWC on the closing date comes to negative $1M and the purchase price is $100M, the "true" purchase price will be $99M in order to get NWC to $0. I've seen this a few times recently and I think a lot of people prefer it because it's easy and clean and you don't have to try to figure out what a reasonable peg should be. Obviously this doesn't seem as attractive from the seller's standpoint, but it's a negotiation point and the original purchase price in the LOI may have to be altered to come to a common ground.
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