A working capital barrier is designed to ensure that the purchaser receives the intended combination of assets and liabilities (i.e., the normal working capital of the company required for management) as part of the transaction. It is possible to change the composition of current assets and liabilities without affecting profits and EBITDA, so that a seller can keep his EBITDA but not deliver the promised mix. As a result, the buyer would end up with less future cash flow than he had anticipated. (“Peter”).  Chicago Bridge agreed to sell Stone to Westinghouse, among other things, for a purchase price of zero dollars and certain limitations of liability that would give Chicago Bridge a clean break from the rising costs of nuclear projects, in which Stone was primarily involved.  The parties agreed that Westinghouse`s sole remedy, in the absence of actual fraud for Chicago Bridge`s breach of the representations and warranties in the Agreement, was to refuse to enter into the transaction.  In other words, Westinghouse agreed, for example, that it would have no recourse to a breach of Chicago Bridge`s statement in the purchase agreement that Stone`s financial statements were in compliance with GAAP. Westinghouse also agreed to full compensation to the Chicago Bridge for all future Stone-related claims and to obtain compensation in favor of the Chicago Bridge from utilities that would ultimately own the nuclear power plants built by Stone.  Buyers and sellers often agree that the valuation of a target company assumes that the target company will be sold cashless, debt-free and with normalized working capital. With respect to working capital, which is generally defined as working capital minus current liabilities, the buyer wants to ensure that the target has sufficient working capital to operate in the normal course of business after closing without the need for a capital injection. In general, working capital is defined as the operating liquidity available to a business. It is generally calculated as working capital (excluding cash) minus current liabilities (excluding liabilities), but the specific calculation of working capital for a transaction is defined in the share purchase or asset purchase agreement.
Some transactions may include cash and/or liabilities in working capital or exclude certain current assets and/or liabilities, such as . Β accrued interest charges or income taxes. In most M&A transactions, the parties arrive at the purchase price by multiplying the target company`s earnings before interest, taxes, depreciation and amortization (EBITDA) by an agreed multiple. However, before closing a deal, a seller can juggle the company`s assets and liabilities to reduce the company`s future cash flow without affecting EBITDA or therefore the purchase price. To protect the buyer`s interest in these future cash flows, many M&A transactions involve a working capital barrier. Finally, a working capital barrier can also prevent some non-cash flow problems. For example, if a seller expands accounts payable, it could alienate sellers and create a tricky situation when the buyer takes over. An obstacle increases the likelihood that the buyer will receive the expected relationships in addition to the expected cash flow.
Another complexity in the calculation of working capital is that working capital is irregular. Working capital numbers can be unpredictable as customers change their payment habits or terms, customer payments are large and scarce, businesses buy inventory in large quantities, or payment habits to suppliers change. Working capital management is one of the most important issues a company faces. Companies can reduce their financing costs, increase the funds available to grow the business, or increase returns for shareholders by effectively managing working capital. To the extent that management is able to generate cash in excess of the amount required for the Company`s day-to-day operations, it may use such excess proceeds to repay debt, invest in the business, return excess funds to shareholders, or a combination of both. In almost all transactions, a buyer requires a selling company to leave a set minimum amount of working capital. A company uses its working capital (current assets minus current liabilities) to finance its day-to-day operations. In the context of mergers and acquisitions, buyers will consider NWC to be sufficient, essentially the same as the other assets acquired in the transaction. At first glance, a recent Delaware case, Chicago Bridge & Iron Co.
N.V. v. Westinghouse Electric Co. LLC, 2017 WL 2774563 (Del. 27. June 2017), to support the seller`s point of view. However, the case contained some very unusual facts that ultimately limited its usefulness to the negotiating table for the buyer or seller. In that case, the Delaware Supreme Court overturned the Decision of the Court of Chancery that had upheld Westinghouse`s right as a buyer to use the post-closing working capital adjustment process to assert that Chicago Bridge`s financial statements as a seller were not based on proper application of GAAP. The Delaware Supreme Court noted that the adjustment process is a “narrow, subordinate, cabin-like means” intended solely to account for changes in the target company`s business between the signing and closing of the transaction.  As part of financial due diligence, the parties and their advisors should endeavour to understand the working capital required for the operation of the acquired company, as it is currently or likely to be managed, when determining the purchase price. Otherwise, the seller could leave money on the table in the form of excess returns that he had not paid himself before, or the buyer might not receive the full value of his purchase price because he might need to bring capital into the company shortly after the acquisition.
Working Capital Objective The buyer in each M&A transaction wants to have sufficient operational liquidity and negotiates a “target” with the seller. This number is the amount that the buyer wants to have at the closing table to continue its activities and generate revenue. It can be helpful for buyers to find an accurate target working capital by looking at the net working capital at the same time over the past 6 to 12 months. Liabilities that are often included in the determination of net working capital include: Conversely, things that are generally excluded from net working capital are: This decision leaves open the question of whether Delaware courts would review the adjustment process contained in traditional agreements where the buyer is not subject to a limit of liability in the same limited way. Some buyers will be tempted to argue that this case represents a close implication that does not preclude buyers in the traditional context from making statements regarding GAAP compliance in the post-closing purchase price adjustment process. .