By Keshav Narendra-Babu
Working capital is the operational liquidity of a business or the capital need in order to run the business, usually defined as current assets minus current liabilities. It is essential to maintaining business operations.
Buyers of a business want to make sure that there is enough working capital left in the company in order for a smooth transition and efficient operations post-acquisition. In order to ensure this, buyers analyze the amount of working capital used in the company’s past months and calculate a working capital peg. A working capital peg is a specific target for the working capital needed in a company at the closing of an acquisition.
In order for a sale to be made, both buyers and sellers have to agree on a specific peg amount, and after the acquisition is confirmed, an outside assessor analyzes the
final balance sheets in order to determine the amount of working capital that was kept in the business. If the seller kept more working capital than the peg target, the excess amount is paid by the buyer to the seller. If the seller kept less working capital than the peg target, the deficit is paid by the seller to the buyer.
Negotaitions around working capital can present some of the most contentious parts of a business sale. Disputes often arises in the last few stages of an acquisition, when final terms are being negotiated. It’s important for business owners to understand the implications of working capital throughout their selling process in order to better position themselves
to receive a fair price for their companies.
Given the interests of all parties regarding working capital, it is important to strive for accuracy in calculating the working capital peg. There are several factors to consider, including the seasonality of a business, as the timing of an acquisition plays a significant role in working capital discussions. A seller should be looking over past balance sheets in order to compute average working capital and prepare early for working capital pegs that will be captured in the LOI. In this way, the seller is better positioned to preserve as much value as possible while also servicing the buyer’s needs and concerns in a fair manner.
See also:
Further reading from BDO, an international accounting firm
The perspective of an investment bank
Some thoughts from a small private equity firm