Purchase price adjustments : question
Hi guys,
Say you are looking at a software company with $10m in recurring revenue.
The company sells mostly 3 year contracts and collects 100% upfront.
So, on paper revenue looks good as it piles up over time BUT cash has already been collected (high DR balances).
Of course a seller wants to sell for a multiple of revenue AND take the cash on the account when he leaves in a cash free/debt free deal.
How do you address this issue? The acquirer will be left with a company with no cash to collect but OPEX to pay...
Would you consider all AR longer than 1 year a debt instrument and do a dollar for dollar adjustment for instance or are there other ways to handle that?
Thank you
The buyer would try to negotiate a purchase price reduction through a working capital adjustment. Your accounting is slightly off. If revenue is collected upfront, you'd have a large deferred revenue (or similar current liability) balance, and your net working capital would be negative. Any buyer will argue that normalized net working capital should exclude deferred revenue or that deferred revenue should be treated as indebtedness.
Working capital adjustments and indebtness are typically treated the same way (purchase price adjustment) when acquiring a business. So the buyer will effectively get the cash that was collected upfront for services yet to be delivered if they structure the deal properly.
Apologies, I just realized my autocorrect switched DR for AR in my post... I have amended my question.
So yes: 100% collection upfront of multi year contrats creates large DR and cash balances.
So what you are saying is: either buyer keeps the cash and doesn't change the valuation or treats DR as debt and reduces the valuation on a dollar for dollar basis. Am I right?
How would you counter the argument: "but this is just a timing issue, these customers will renew". Would you consider including ST DRs ( 12 month) in the WC calculation and exclude LT DRs in this case? Would you factor in the churn rate? (knowing that 3 year contracts distort the reality of the churn rate...)
Thanks!
Only nuance is that net debt is a dollar for dollar reduction where as NWC using completion accounts is a change vs peg.
Reaching agreement as a buyer that DR is debt is more valuable.
I've definitely seen software companies bought on cash ebitda and no consideration for the large def rev balance ie normalized net working capital was negative and no debt like treatment. Not in tech but people tell me that's market
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