The Working Capital Adjustment | Introduction

The working capital adjustment in a stock purchase agreement can have a direct impact on the price paid for the business. Given that price is arguably the most important variable in a transaction, and that the working capital adjustment can impact price, it follows that the working capital adjustment deserves special attention.
This video demonstrates how critical this calculation with a narrative that follows the founding and sale of a business. It is part of the Private Equity Training course titled "Closing Deals" (www.asimplemodel.com/model/17....
Private Equity Training:
www.asimplemodel.com/PrivateE...
Stock Purchase Agreement:
• The Stock Purchase Agr...
Purchase Price:
• Purchase Price in a St...
Cash Free Debt Free:
• Cash Free Debt Free - ...

[@lovelife655]

This is a FANTASTIC video, thank you so much. You have broken down such a complex topic into something digestible and easy to understand! I love it, please keep digging into this topic.

[@ASimpleModel]

Thank you! Really appreciate the comment. We likely will have more WC content on CZcams in the future. There is definitely a lot more on the website as part of the Private Equity Training curriculum should you have any interest: www.asimplemodel.com/PrivateEquity

[@bigbphototronic]

great video! Thanks

[@christianpeters5218]

Thanks for this video

[@ASimpleModel]

Glad you enjoyed it!

[@honestrunescaper]

Nice 👍

[@rahlok8271]

I love your videos

[@ASimpleModel]

Thanks!

[@All_you_need_is_love2018]

EBITDA adjustments is just as important as the WC adjustment. Getting to a normalized EBITDA and WC are key.

[@ASimpleModel]

Great point! Could even argue EBITDA adjustments are more important since purchase price is expressed as a multiple of EBITDA (depends on scale of course). Either way you're spot on, both are critical.

[@muddassirlaique5868]

Great video Peter! For clarity, if you did have some payables in there, would Target Working Capital = AR + Inv - AP?

[@ASimpleModel]

Thanks! And that's correct. All accounts agreed to by both parties would be included. Current assets increase the NWC and current liabilities decrease NWC.

[@jd5787]

Thanks! I have some questions in the context of Software M&A (not much by way of inventory). Say it is a cash free/debt free deal where the target has 80% of its customers renewing annual and multi annual contracts on the same month which happens to be around closing. Now there is cash in the bank and a pile of DRs on the balance sheet. The target is already not a profitable business which means buyer would need to cover all the expenses for the next year. How does buyer keep the cash in the business? (it would not be fair for seller to walk out with the cash and the buyer having to foot the whole bill for the year).
What would be the best NWC definition? How to best fix the peg? How to assess the DRs? Thanks!

[@ASimpleModel]

This is a great question that generally requires some negotiation and understanding of the business model. In this case since the DR is all cash (not backed by AR), additional variables to consider would be the cost of customer acquisition vs the cost of delivering the good or service. If a substantial amount of expense is associated with landing a customer, some of this cost and perhaps a profit tied to this cost should benefit the seller. But if the bulk of the cost is associated with the delivery of the good or service, then you are correct to point out that it would put the buyer in a tough spot in a cash free debt free transaction where deferred revenue was included in NWC. In this instance it may be better to include most DR in the definition of indebtedness instead (which would reduce purchase price). The buyer could then include an appropriate amount of cash under sources (sources and uses table in your model), secure a revolver undrawn at close for this purpose, or negotiate the amount of cash required on a go forward basis with the seller. The seller, however, would likely counter and say that it's just a timing difference (if the balance remains stable throughout the year). I may have to write an article on this. Thanks for posting the question!

[@jd5787]

@@ASimpleModel thanks for the reply! It would be great if you could expand on NWC sometime. What goes in/out (not just at a high level), what can be negotiated and some workaround like the one you have suggested with the revolver. I think that would be quite unique as all online resources only scratch the surface.

[@ASimpleModel]

@@jd5787 That is great feedback, and we are working on it. But much of this content will be for the Private Equity Training Curriculum (for subscribers, currently $14 / month). You can find another video on this topic here: www.asimplemodel.com/model/17/closing-deals The second working capital video explains the difference between GAAP working capital and NWC, walks through why seasonality makes it difficult to target the working capital peg, and then defines how this adjustment actually takes place with examples of the documents that get exchanged in the process.

[@jd5787]

@@ASimpleModel thanks! OK, I will subscribe next week and review the content. Any roadmap on what you will teach in the coming months?

[@ASimpleModel]

@@jd5787 The best way to get a feel for the course is the curriculum page (www.asimplemodel.com/PrivateEquityTraining). Unfortunately we do not yet have a road map, but I will be announcing updates via the newsletter. (A roadmap is a good idea though...)

[@ivantan3554]

If a question says "additional working capital of $100,000 is required" does this mean that i should decrease it from my cash flow?

[@ASimpleModel]

if working capital grows by $100K it will need to be funded via cash or the revolver, either way it is a use of cash.

[@paulb2022]

You simply can't get a more succinct working cap adjustment run down that this.

[@ASimpleModel]

Thanks Paul! This will be followed with a piece that details all of the documents exchanged between parties to actually make the purchase price adjustment. Part of a larger series on the private equity process. Hope you enjoy it when its up!

[@paulb2022]

@@ASimpleModel hey when do you expect to have more on the purchase price true up? in the middle of explaining this to a vendor who evidently didn't understand the concept in its entirety.

[@ASimpleModel]

@@paulb2022 Hi Paul, please email me via the contact page at ASimpleModel.com (www.asimplemodel.com/contact.aspx). I will follow up with some additional notes.

[@mamthamathew1810]

How can we calculate due diligence working capital

[@ASimpleModel]

There is a lesson that describes the process of calculating the working capital peg using a simple seasonal business as an example, but it is subscriber content. If you are interested you can learn more about it here: www.asimplemodel.com/model/115/closing-the-transaction/working-capital-adjustment-process/

[@stevea982]

Sorry maybe I missed it--where is the more realistic example follow-up video?

[@ASimpleModel]

Hi Steve, the follow up is on the website as part of the Private Equity Training curriculum: www.asimplemodel.com/financial-curriculum/private-equity/ It is a 12 page PDF document that explains (1) the definition of working capital in the context of a transaction (different from accounting definition), (2) how the calculation is made (using a business with seasonality for additional complexity), (3) the documents exchanged between the parties to confirm the working capital peg and make the party whole in the event that an adjustment is required. You can find it in the course titled Closing the Transaction. In this context, I thought you might also find this video interesting: czcams.com/video/sDx49v2OYWQ/video.html
Hope that helps!