Working Capital - Beware the Peg
March 12, 2021
by a professional from University of Wisconsin - Madison in Green Bay, WI, USA
Searchers - beware the working capital peg. The peg is meant to ensure an appropriate amount of fuel is delivered to take over the business in the normal course of business. It also ensures the seller continues to operate the business in the normal course through close. However, there are a ton of pitfalls - seasonality, non-operational current assets/liabilities, deferred revenue, etc and this in reality can affect your ultimate purchase price and indirectly your valuation.
I obviously recommend setting a peg in the purchase agreement but there are different ways to calculate it and to work together with a cooperative seller to ensure it meets the objective of both parties. I recommend using an advisor to help you think through the balance sheet and associated working capital peg.
from The University of Chicago in Chicago, IL, USA
I recommend WC PEG should be in the LOI, not in the Purchase Agreement. I also know many, if not the most, brokers, do not provide adequate info to help determine PEG early in the game. There are workaround to that too.
Here is an actual example of delaying WC..
Recently there was a $40 Million purchase price deal that fell apart after 12 months. All documents were signed except the main SPA. Parties could not agree on one word in the SPA. I mean parties could not agree on one word. in the sentence "For $40 M, WC at Closing will be $x". Two times the parties had walked away from the deal. 3rd time, it was Thursday, they could not agree again. Both sides, total frustrated, asked the attorneys to destroy all papers and said the deal is dead forever. I got the call from one attorney that Thursday. He said he can ask all to wait one week if I would look at the deal and help resolve the issue. The Buyer (a large top-class PE firm) was represented by PwC, and the Seller was represented by a reputed accounting firm with 12 offices. I was surprised that the LOI had no PEG; it just said "the business will leave adequate WC at closing". The reason they could not agree on WC was a) the definition of WC, and b) its quantification. This was a healthcare deal where "labels" on the balance sheet often have to be interpreted from M&A perspective, not accounting perspective. I got the parties to agree and we closed in one week.
My point is that WC is critical in M&A transactions, and to hear some template from B-schools treat it lightly is an injustice to the entrepreneur.
from The University of Chicago in Chicago, IL, USA