Negotiating the Working Capital Peg

How I thought I looked

I stood at the craps table, energy palpable, with no idea what I was doing. I found myself out for a night on the town with my new colleagues from the PE firm I worked at. They all seemingly had PHDs in anything you could put odds on… Dice, Golf, Horses… you name it.

I, on the other hand, was relatively risk averse, and not great at games with a lot of “rules” you had to remember.

Needless to say, craps was not a natural fit. And it was a short outing.

Two rolls and everything I budgeted for “fun” that night was “gone”.

To add insult to injury, the dealer looked up with a sly smirk and exclaimed:

❝

“You’ve gotta gas up the bus if you wanna go on the field trip.”

Demoralizing.

(Where is he possibly going with this…)

Managing working capital levels is like gassing up the bus for a field trip. In order to get a certain amount of production out of your business, you need to inject a certain amount of fuel so the bus can go where you forecasted.

Live footage of a deal falling through

And when one company buys another, it expects the ~~bus~~ company to still run, and not stall out, for a certain number of ~~miles~~ months post acquisition. Buyers look at acquiring a business like acquiring a constant stream of cash flow, accompanied by the assets required to generate said cash flow, and supported by a normal level of working capital.

The all-important (and subjective) word here is “normal”.

Here’s the rub…

Most deals close on a cash free, debt free basis. That means the seller gets to keep all the remaining cash on the balance sheet after paying off any existing debts. Why?

The buyer doesn’t care about your debt, as that was your own financing decision, which they don’t want to inherit
- Caveat: They actually might if it’s a sweat heart ZIRP 3% revolver or credit facility. But that’s not the norm.
The buyer also doesn’t care about cash, as it would be tax inefficient to buy cash with cash - it would increase the purchase price and associated taxes on the transaction. They’d rather use their own.
- Caveat: They probably need a few bucks in the bank account upon closing to pay for small office expenses, a few weeks of payroll, etc. But you try to keep this to a minimum. As a buyer I’d rather use my own cash, unless it’s a logistical problem.
So the working capital adjustment is everything you agree is included “in between” that’s not debt, and not cash, and needed to make sure people get paid and the business can produce a consistent stream of cashflows for a temporary period of time. (Source)