EV and NWC adjustment
I have a question about purchase price adjustment for normal NWC and DCF.
The DCF accounts for changes in NWC. Lets say a deal is priced on December'20 accounts, and that NWC is significantly higher than "normal" (average 12 months) in Dec'20. In that case the DCF accounts for that higher NWC and the possible unwind back to normal levels (lower NWC in Dec'20 for example).Therefore the resulting EV should already reflect the higher than normrouterloginal levels of NWC (through the change during the FC Y1). So, if there is a purchase price adjustment for normal levels of working capital in the deal, then this should mean that NWC is double counted if added to the DCF EV? As the EV from the DCF al192.168.0.1ready is reflective of the higher NWC at closing?
Not sure if I exactly understand what you’re asking for, but sometimes you see a working capital peg negotiated into the terms of a deal. Working capital pegs ensure that the buyer of a company has a sufficient amount of working capital when they receive the company day 1 and the seller doesn’t take unnecessary operational decisions to boost their cash balance to benefit them in a cash free debt free deal. The working capital peg is highly negotiated on an account-by-account basis and is typically supported by a QofE analysis or some other opinion.
Agree with Trebita. NWC is negotiated. For example, unearned revenue can be argued as NWC or as a debt like item.
The EV is typically largely agreed prior to the details of NWC being set. For MM PE, EV is usually EBITDA (or similar) * earnings multiple.
As part of the purchase price adjustment post closing the NWC vs peg is evaluated and paid to or by the seller/buyer depending on the outcome.
Your DCF year 1 cash flows should use the working capital peg as the basis point for the change.
Let’s say actual 12/20 NWC is 8, term sheet “normalized/required” NWC is 10, and Year 1 proj NWC is 15 (projecting growth, assuming non-negative NWC type business). You should have the DCF year 1 cash flows reflect a change from 10 to 15. The value should be accounted for in one of the clauses of the purchase docs. In this case, seller would provide an additional 2 cash at close to meet the peg, which is where the value accounted for. And then obviously all other DCF years would just go from preceding year projected level (it’s only first discreet period that needs to be looked at like this)
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