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Understanding Working Capital Hurdles in M&A


After parties decide they wish to embark on a merger or an acquisition (M&A), a lot can change at any moment that could alter the terms of the deal or kill it altogether. One of the buyer's understandable concerns is that the company it inherits won't be on the same financial footing it was when the decision to purchase occurred. Given how long it can take to close the deal, there could be a change in the acquired company's assets or liabilities that could significantly affect the business's value and future. As a result, the dealmakers usually rely on the inclusion of a working capital hurdle. This is a predetermined sum with respect to the required balance of assets and liabilities of the acquired company that the buyer expects. The amount usually factors into the purchase price so that if the company mishandles something during the transaction, the final price can be adjusted as needed. Here is what sellers need to do when it comes to handling that working capital hurdle:

Make a Plan

The working capital hurdle will have to be figured into the target company's ongoing budget while each phase of the deal plays out. If the transaction is expected to take six or more months to finally close, creating and implementing a concrete plan and strategy will be vital. There will be a lot going on during that time, and leaders may begin to neglect certain facets of the operation. Even the slightest oversight could cause a change to the company’s financial situation, as interests charges may be applied or the enforcement of an outstanding contract could result in litigation costs and maybe even damages. If difficulty maintaining the budget is even a remote possibility, it may be necessary to hire a bookkeeper or other professional to stay on top of the books. The key is to make a strict plan and to stick to it to ensure that the expected purchase price will not be affected.

Stay the Course

Once the wheels are in motion to sell the business, it is not the time to start making drastic changes. Company leaders may be tempted to take measures to ramp up the business to impress the prospective purchasers, but if they have made an offer to buy then they are likely satisfied. The working capital hurdle does not just address negative changes to the company’s financial picture, it also places limits on what would generally be considered positive changes. For example, if a seller suddenly starts diligently collecting its accounts receivable, then the buyer will not be privy to that future cash flow that it had expected. To remain within the confines of the working capital hurdle, the best way forward is to simply stay the course.

Document Changes

It would be unrealistic to think that over the course of six or more months that nothing is going to change. A company’s finances are generally influenced by a host of factors, with some being easier to control and account for than others. Once an M&A transaction is happening, employees may start to depart in droves which could drastically impact the payroll budget and taxes or production may have to slow down due to changes to personnel and resources. In these instances, the company just has to be smart about how it approaches things and only take reasonable actions that the buyer would likely understand. More importantly, any changes that occur must be properly documented so that there is a paper trail and tangible evidence of the need for a particular course of action.

Communicate Everything

As mentioned, it is likely impossible to avoid some kind of change at some point before the deal actually closes. Hopefully, there will be a plan in place to avoid an event with enormous financial consequences and any smaller items will be attended to wisely and swiftly. In addition, the best way to ensure that a potential problem does not actually become a problem is by maintaining transparency from the get-go and avoiding unwelcome surprises. Rather than wait until everyone is at the closing table to divulge that the working capital hurdle has not been fulfilled, the parties should be communicating as things are happening. This will promote trust and allow for both sides to problem solve in a collaborative fashion.