I'm building out my financial model, using the Stanford Sample Search Fund Financials (exhibit 12) as a guide, and I'm stuck on forecasting changes in net working cap. Stanford's model is using 20% of annual revenue growth as the delta of working capital, so for a growing company this would be a signficant drain on available cash to pay down debt or distribute early to investors, and is crushing my model for a services business that has minimal capital or inventory requirements. I looked over the company's balance sheet and they grew $4m in revenue between 2018 and 2020, and the cumulative change in Net WC was a positive $200k. Is 20% of revenue growth way too conservative? Any advice on how you are modeling this for your deals?
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Few comments:
1) Accounting WC and M&A WC are different.
2) The concept of DFCF balance sheet is for beginners. Apply that to a subscription based business and you are DOA.
3) WC is unique to each business. Some of the best businesses I have sold had negative WC.
4) WC = 20% of sales substantiates the difference between professors and practitioners.
5) Build pro-forma model as-if WC is included in the deal on day one. This will reduce errors in model development. If WC is excluded in actual deal, make sure you have it is funded externally. In general, both the buyer and the seller are at RISK if WC is excluded.
6) 12 months average of each component of WC (sometimes more) is a good start. Exceptions, like faster inventory turn, can be modeled if needed, but this should not be the norm.
7) Major WC items (A/R, Inventory, A/P) typically grow proportional to sales.
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