How to treat large customer deposit account in buyout

September 24, 2022

by a searcher from University of Southern California in Orange County, CA, USA

Interested in thoughts on how to treat customer deposit liabilities in an acquisition.

Target tends to run negative net working capital due to sizable advance customer deposits. These deposits are paid to reserve the provision of the company's services at a future date. Balance could run as high as 50% of the purchase price at close. NWC excluding cash has been relatively consistent over time. NWC including cash has fluctuated much more dramatically based on the amount of cash on the seller's books. Cash as a % of customer deposits as been as low as 25% and as high as 150%, most recently hovering around 100%.
Currently I'm treating this account as debt (essentially a loan from future customers), requiring that the debt be extinguished at close and excluding this account from the NWC peg process. Obviously I don't want the seller to go and refund these deposits, so the way to effect this would be having him leave an equal amount of cash in the business at close (preferable) or through a revision to the purchase price.

However, I'd like to be sure that I'm making a market ask. At some point his outside accountant will have eyes on this so I'd like to know in advance where the common ground is likely to be. Thoughts and advice from this community are welcome!

Reply by a searcher
from University of Pennsylvania in Charlotte, NC, USA

Good question! We've resolved this issue in several ways and the nature of the business operations matters significantly. Your question is what's a market ask, not what you'd ideally prefer to have. One negotiated approach is to attempt to determine the actual value of the deposit liability - in other words what will the buyer have to expend to fulfill the product or service obligation (maybe plus a "normal" profit margin.) That is the amount of cash that should be left for buyer.. Please note, there are some challenges and issues with this and it doesn't make sense in all businesses, but in my experience it's seen as a relatively fair and balanced approach.

Consider a situation where the business has taken a 100% non-refundable deposit, produced the product, wrapped it and set it aside for shipping to the customer. At that point (in most accounting) you have the full amount of the deposit liability on the books. It's going to be tough to require that seller leave that amount of cash in the company (or treat it as funded debt that reduces the purchase price.)

Curious where you are in your transaction process. If you've signed an LOI, how did you address this when stating the purchase price and what you are buying? It sounds like it's a material portion of the deal value.

Reply by a searcher
in Tyler, TX, USA

Jon, I had a deal fall through where deposits were a meaningful part of the consideration. I generally agree with Robby's perspective above (although it's not always easy to convey to a seller that the cash in the bank isn't theirs, so giving them the cash and taking a purchase price reduction may be a way to resolve the issue if it's a sticking point -- although to Robby's point, you do then have to find money to fund operations in the interim).

The other consideration I'd bring up is that often, especially in businesses with longer lead times, the deposit funds may have been used to purchase materials. I've seen both in searching and in LMM PE, the use of a "net deposit liability" that took the difference of deposits less spend on related projects as the "debt-like item". Can do this at the project level if possible, or can make certain reasonable assumptions to arrive at this.

Didn't write a book about it like Mike :), but happy to talk further if helpful, just DM me.

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