"Negotiated working capital target for a deal" - what does this mean please?

newkid2019's picture
Rank: Baboon | 105

Hi everyone:

I'm just browsing some current PE associates experiences and saw some of them mention that they "negotiated working capital target" for a deal that they worked on. Pardon my ignorance, but could someone enlighten me on what does mean and how does it actually work please? How do you go about setting a quantitative target (do you compare to similar firms, or use some type of financial metrics), and usually, what are the levers one can pull in negotiating this?

Thanks!

Comments (14)

Jan 21, 2019

It's a way to make a couple extra bucks (or save a couple extra bucks) outside the headline number. In any deal you set a target amount for working capital to be delivered at close. If delivered working capital differs, the difference is reflected in actual considerations delivered. The negotiation of the working capital is in both determining the methodology and what is included. There's no set definition for what is and isn't included, so both sides will push for certain items because it will result in a higher/lower target. It's quite the little dance.

    • 6
Jan 21, 2019

Spot on. To add some additional color, its basically including/excluding various assets liabilities in order to adjust the purchase price.

So I could say "Hey you're including all AR over 90 days as a current asset whereas in reality we're not going to be able to collect any of that, so I want current assets reduced by $xxx"

Then they would come back and say "Well we typically recover x% of that amount based on historicals so how about we adjust by xx%"

You can basically do that for most Current Assets and Liabilities

    • 5
Jan 21, 2019

Too add some additional color (again) - this is because most deals are cash-free / debt-free, so working capital targets are usually included in purchase agreements so sellers can't unfairly drain the company's working capital to try to boost cash balances. Ex: Seller could hold off on buying inventory to increase the cash they would walk away with.

    • 5
Jan 21, 2019

thank you so much @Banking Sucks Guys!

Jan 22, 2019

Thank you, @NuclearPenguins , @Banking Sucks Guys , and @mrharveyspecter ! SB sent to all of you, thanks for the detailed response.

I have a follow-up question if you don't mind (I've gone through PE interview guide but didnt find a detailed desceription of the process). I think I'm still confused because I don't know the process of closing well. When a deal is being closed, what are the metrics that are defined in the agreement? Why would working capital to be delivered at close - does an amount of cash equal to the working capital change hand, or is it just the amount of working capital that the company has to have on its balance sheet when the company changes hand? Thank you!

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Jan 22, 2019

That is most likely because there isn't a "one-size-fits-all" when it comes to the process of negotiating the NWC target. Often times there are multiple "gray" posts within both NWC and NIBD, that will be up for discussion during the due diligence/negotiation-process.

If your NWC differs from the NWC target agreed in the SPA (Seller's Purchase Agreement), the old owner will receive the agreed price +/- the difference in working capital at the date of closing.
Unless it's a very cash heavy operation the difference tends to be small, and not matter all that much.

    • 3
Most Helpful
Jan 22, 2019

As an analogy, let's say you offer to buy a car for $10,000, but your $10K offer assumes the car has a full tank of gas. If the seller then delivers to you a car with an empty tank of gas, in order for you to be made whole on the deal that you struck, you would just deliver to the seller $10K less the cost of a tank of gas.

Real deals are sort of like - fairly specific and to be delivered with "normalized levels of working capital" (or something like that). So if a business at closing has less inventory than is agreed to be "normal" (all else equal) then the buyer deducts that difference from the purchase price. This is always a negotiation and people oftentimes default to a trailing twelve month average NWC that is normalized for non-operating liabilities or one-time things, writeoffs, etc. Can be particularly challenging/contentious if you have a very seasonal business. Really just a matter of trying to make sure neither side games the process or unduly benefits/is hurt by actions leading up to closing.

    • 9
Jan 22, 2019

Thank you!

Jan 22, 2019

Is it considered a big deal/value add to have negotiated this for associates? It seems fairly normal from you guys' description. Thanks!

Jan 22, 2019

It really depends on the deal. I would say that it is more common for PEs to complain about this, especially if you stack them up against a traditional strategic buyer.

Despite hiring help, that is hiring some intermediary to do a vendor due diligence or similar, a strategic buyer will often look in other directions to find value because the acquisition can produce synergies with their bread and butter. If Target thinks that they can save 50 million in administration each year by acquiring a supplier, they're not gonna care too much if the NWC is 45, 48 or 51 million.

On the other hand, unless the PE fund already has a platform investment these synergies are non-existing, meaning that they have to look elsewhere in order to maximize returns. Most of this is done by talking down the price in the initial stages, which is why financial buyers tend to pay less, and the other is fighting over more technical things such as working capital or interest bearing debt.

Even if it is a small sum of the entire transaction it is one of those places where lower ranking PE employees, read associates/analysts, can show that they have added some real value to the transaction. If you can talk the NWC up 5 million, that's 5 million "straight in your pocket". Most PE guys also have IB background and know what posts can be considered "negotiable" or not.

From my experience, it's usually not a big problem, but... I swear to God, certain douchebags will even fight you down to the vending machines and how many Snickers bars is considered "appropriate".

    • 4
Jan 22, 2019

This is amazing, thank you so much!

    • 1
Jan 28, 2019

There's also the factor that once you get to this stage in the process, the lawyers are doing most of the heavy lifting and NWC is one of the few areas of the PA that the bankers can still"add value". This often leads to an excessive amount of negotiation on an oftentimes immaterial amount of money.

Jan 28, 2019
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