Question regarding working capital.
November 10, 2021
by a searcher from University of Redlands in La Quinta, CA, USA
"The notion that there is no working capital is not acceptable for any buyer. We are buying a business and a business needs working capital in order for it to be a functioning business. Therefore, an acquisition normally includes an agreed-upon amount of working capital to be determined via due diligence and negotiation."
Thoughts on this statement?
from Wake Forest University in Winston-Salem, NC, USA
In terms of valuation and pricing, your DCF model should incorporate the cash required to support NWC as it changes over time. For the multiples approach, the requirement is to be consistent with the data construction of the database of comparables and price accordingly as to whether it is the base price or the combined price (base plus working capital). For example, PeerComps explicitly excludes the AR and AP components of working capital in its Enterprise Value (it does include normal inventory, FF&E, and goodwill). Thus, the value derived using the PeerComps multiple is the base value + inventory, excluding AR and AP components of NWC. If one was interested in the combined price (base + WC), as some buyers are, they would simply add the NWC to the base price to get the combined price. On the other hand, if you are using Deal Stats (fka Pratt’s stats), it sometimes does and sometimes does not include NWC. Deal Stats requires you to look at the detailed record of each transaction to determine if it does or does not. For a transaction that did include NWC, Deal Stat’s enterprise value would be higher than the same transaction in PeerComps by the NWC, and thus the multiple would also be correspondingly higher. Going in the opposite direction, BizComps explicitly excludes even inventory (it only includes FF&E and goodwill). So, when using that database, you multiple the SDE or EBITDA by the multiple, and then have to add the inventory value to get to the base price (including inventory).
Whether or not the asking (or offered) price includes or excludes net working capital (i.e., is it a base price, or base + NWC), how they arrived at that decision, and what the working capital needs of the company are, should be clearly laid out in the confidential memorandum, and also documented in the LOI and purchase agreement. Definitely not something that you want to wait until close to closing to negotiate.
Once you decide which components of NWC are included and which aren't, then work out a structure with the lender; there isn't any arbitrage one way or the other, it's just the commutative property (A+B=C).
from The University of Chicago in Chicago, IL, USA
1, Total cost to buyer includes WC. The actual transaction price may not.
2. Ron Buck's post provides excellent summary of the differences between multiples from different databases.
3. In my 35 years as an M&A intermediary, my transactions have ALWAYS included WC (and except for one, they al have been under $50 M in value). I was President/Chair of AM&AA for 12 years###-###-#### deal makers, average transaction $15-20M). Exclusion of WC was not even a topic of discussion.
4. A buyer should always takeover WC. Leaving WC in the hands of the Seller is risky for the buyer. Taking over WC will require WC analysis. That will show any hidden skeletons. And, seller will not stand by WC if he has played games.
5. I do not recommend the alternative of getting WC financed through LOC from a lender. It may be Ok for some mom-and-pop business, but not for the size businesses that I see Searchers are looking to buy. In general, a buyer needs more out-of-pocket cash if you exclude WC from the deal and go to a lender for its financing.