A buyer will have a reasonable expectation that the company they’re buying will be passed to them with a normal level of working capital so that they continue trading in the short term without an emergency injection of funds. It may not come as a huge shock to learn that the definition of “normal level of working capital” can become contentious, examples of debatable areas being:
- What actually constitutes working capital?
- Over what period is a normal level established for?
- How are exceptional items that create spikes to be dealt with?
With a normal working capital level established, the next step is to compare this to whatever the level of actual working capital is at the date of completion. Completion accounts are normally prepared shortly after completion to facilitate this comparison. Where actual working capital is in excess of normal working capital there is, in effect, an addition to actual cash (the reverse being true as well) as part of the price adjustment.
An alternative completion mechanism is the so-called “locked box”. Here, instead of using completion accounts to assess a working capital adjustment, a balance sheet for a period end close to completion is used. This introduces the ideas of leakages (permitted or otherwise) from the locked box position, and value accruals to the locked box position. The attraction of the locked box is that a price adjustment is established and is payable upon completion. Buyers are therefore going to want to protect themselves by performing extensive DD work on the locked box balance sheet, and by having remedies available in the SPA.
We’ve worked on a deal recently where each party had a different interpretation of what the headline price stated in the Heads of Terms actually meant, and this sort of misunderstanding can entirely derail a sale process once advisers start to work for their respective parties. The advice therefore is to engage with advisers at an early stage to ensure there is sufficient clarity in the Heads of Terms before you start running up hefty transaction costs. At UHY we can provide this engagement to buyers or sellers as well as support throughout a transaction and beyond.
The next steps
Please contact James Price or your normal UHY contact if you’d like to discuss our transaction support services.