Working Capital In A Deal: Deal Maker or Deal Breaker?
May 09, 2025
In M&A transactions, working capital is often a critical but underestimated factor. Misunderstandings or misalignment around this concept can derail a deal, impact the purchase price, or create post-close complications. A clear understanding of working capital and its role in deal mechanics can significantly reduce these risks.
What is working capital?
Working capital represents the liquidity available for a business’s day-to-day operations, calculated as current assets (e.g., cash, receivables, inventory) minus current liabilities (e.g., payables, accrued expenses). Most deals are structured on a cash-free, debt-free basis, with an emphasis on net working capital (NWC)—excluding short-term debt—to evaluate the operational baseline of the business.
Working capital from the seller’s perspective.
Before entering the market, it is crucial for a seller to establish a comprehensive working capital mechanism. This should encompass precise definitions and the relevant accounting principles, leaving no room for misinterpretation. Collaborating with a due diligence advisor to establish realistic figures and draft clear agreement language can help ensure a fair and balanced transaction. Neglecting this step may inadvertently provide the buyer with a competitive advantage.
Key considerations for a seller in developing a working capital mechanism include:
- Business Seasonality: Understanding seasonal fluctuations that may affect working capital requirements.
- Business Growth: Anticipating future working capital needs that may diverge from historical data due to growth.
- Industry Working Capital Trends: Being aware of prevailing trends within the industry that could impact working capital expectations.
- Single Transaction Impact: Identify any significant one-time transactions that could cause deviations in the company’s working capital from the norm.
Working capital from the buyer’s perspective.
Buyers rely on NWC as an indicator of operational health and aim to avoid post-close capital injections. The working capital “peg” is a negotiated target that ensures the business is transferred with adequate operating capital. Factors for a buyer to consider:
- Review Working Capital Agreements: Proactively addressing potential issues can prevent delays in closing the deal.
- Accruals & Reserves: Include items like vacation pay, bonuses, warranties, and sales allowances.
- Assess Cutoff Issues: Verify that interim period cutoff issues are adequately accounted for.
- Consider Business Growth: Determine if the business and its working capital needs are expanding.
Avoid letting working capital derail your transaction.
Understanding the intricacies of working capital—an often highly negotiated component of M&A transactions—can significantly enhance both buyers’ and sellers’ prospects for post-closing success. Engaging a due diligence advisor early in the process, particularly during the LOI phase, can help navigate complexities, mitigate unexpected challenges, and contribute to the overall success of the transaction.
Connect With Us.
Patrick Mannion, Managing Director
Transaction Advisory Services
Categories: M&A