Working Capital Whiplash: How to Avoid a Price Cut at the Closing Table

After years of building your business, you are finally ready to sell and you want top dollar. Top dollar translates to a solid purchase price, right? Sort of. While the base purchase price is the headline figure, it is equally crucial to understand common adjustments to the purchase price that can chip away at your payday if ignored or not thoroughly considered. While every M&A transaction is unique and heavily dependent on buyer-seller negotiations, most purchase agreements include purchase price adjustments related to cash, debt and most critically, net working capital (NWC).

WHAT IS NET WORKING CAPITAL AND HOW DOES IT IMPACT PURCHASE PRICE?

Net working capital is generally defined as current assets minus current liabilities; however, in M&A transactions that definition becomes more nuanced. Not all assets and liabilities are treated equally; what counts is what is normal and operational for your business. This is why the negotiated definition matters just as much as the math.

The NWC target is a benchmark for the amount of working capital that should remain in the business at closing. As a seller, if your actual NWC at close is above the target, you get a positive adjustment (more cash in your pocket). If it is below, you will be writing a check to the buyer.

Here is where things get interesting: the target itself is negotiable, and how it is calculated can shift tens or hundreds of thousands of dollars in or out of your favor.

For example, if you and the buyer agree on a $500,000 NWC target and your actual NWC at closing is $600,000, then the $100,000 difference goes straight back to you. This incentivizes sellers to maintain healthy levels of receivables and inventory in the business, rather than draining value or delaying payables.

HOW TO NEGOTIATE A NET WORKING CAPITAL TARGET THAT WORKS IN YOUR FAVOR?

There is no universal formula, but proven tactics exist that sellers can use to optimize the outcome. The earlier you start the process, the more leverage you will have. Here are seven strategies to avoid leaving money on the table:

1. Start early and analyze trends with intent

Get ahead of the negotiation by thoroughly reviewing your historical working capital balances. Develop a solid understanding of the nature of each balance and the factors that drive fluctuations, including, inventory cycles, billing practices, vendor payment timing and more. Flag outliers such as one-off balances, seasonal spikes or dips and be prepared to justify excluding or normalizing them.

2. Propose the timeframe

Do not leave this up to the buyer. As the seller, it is beneficial for you to set a lower NWC target with the goal of achieving a higher number at close. Choose a timeframe that reflects favorable yet sustainable operations, such as including a lower-demand season or a period when the business was particularly operationally efficient. Avoid periods where NWC was artificially high, either due to aggressive cash collection or a temporary build-up of inventory. If historical figures are not the most reflective of future operations (i.e., a rapidly growing business) consider using a forecast-based target.

3. Identify and remove non-operational or seller-funded items

This can look like excess cash or inventory not required for operations, aged receivables unlikely to be collected or expenses prepaid by you that will benefit the buyer. Ensure you document and justify these exclusions clearly, as buyers will generally want to include all the assets and liabilities that they will be responsible for post-close.

4. Forecast your closing working capital in advance

Before finalizing the NWC target, model what your target is likely to be at close using the target methodology. This helps to test your assumptions and ensure your strategy will not backfire in the end. If you are likely to overshoot, consider ways to improve your target position.

5. Lock in the definitions

Ensure you thoroughly understand the NWC mechanics and that there is minimal room for interpretation between parties. The purchase agreement should clearly define what constitutes current assets and liabilities, specify the basis of accounting or valuation methods to be used and outline any special adjustments or exclusions. Clear definitions prevent disputes and confusion during the post-close “true-up” process.

6. Stay consistent before close

Once the NWC target is set, do not make drastic changes to how you run the business. Avoid withholding vendor payments, aggressively collecting receivables or running up inventory levels. Purchase agreements typically require sellers to make warranties and representations to continue operations in the normal course. The buyer will likely notice these tactics and may request to restate the target, reduce the purchase price or initiate legal action due to seller manipulation.

7. Get experienced advisors involved

Experienced transaction advisors can help you build a defensible target, justify key exclusions, negotiate favorable terms and model the impact of different scenarios. Your advisors are your negotiation partners; be sure to use them.

THE BOTTOM LINE

NWC is a deal lever; use it strategically. You worked hard to build value in your business; do not let a misunderstood working capital target quietly give it away. If you are preparing for a sale, start thinking about working capital early. Reach out to an experienced transaction advisor who can help you model the right target, protect your value and avoid surprises at the closing table.