M&A Target Working Capital !

M&A Target Working Capital !

Author: J.J.P. (Joris) Kersten, MSc RAB

Kersten Corporate Finance @ Uden/ The Netherlands

Sunday February 28th 2021

Source used - book: Crushing it as a corporate buyer in the middle market (2020). Kevin Tomossonie. Rock Center Financial Partners, New York.

Introduction Kersten CF

Kersten Corporate Finance is an independent M&A consulting firm in The Netherlands.

Deal segment: Middle sized and SME companies. So companies with an Enterprise Value (EV) of in between 2 million euro and 50 million euro @ The Netherlands and Benelux.

Activities:

1.    Selling companies;

2.    Buying companies;

3.    Business Valuation & Financial Modelling;

4.    Financing of acquisitions with bank loans and/ or private equity firms;

5.    Buy & Build strategies for strategic buyers and private equity;

6.    Searching & selecting acquisition targets;

7.    Finding multiples for precedent M&A transactions in a certain field.

Website M&A consulting: www.kerstencf.nl

Website M&A training: www.joriskersten.nl

M&A training:

·      Business Valuation & Deal Structuring – 6 day training – 7 until 13 April 2021 – Location: Hotel van der Valk Uden/ The Netherlands – Also online available on live stream. 29 PE points for Registered Valuators (RV) from NIRV;

·      Business Valuation & Deal Structuring – 6 day training – 29 September until 5 October 2021 – Location: Crown Plaza Hotel Amsterdam South – Also online available on live stream. 29 PE points for Registered Valuators (RV) from NIRV.

In addition, Joris provides valuation training all over the globe on (bulge bracket) investment banks and universities in: New York, London, Hong Kong, Singapore, Dubai, Saudi Arabia, Kuwait, Mongolia, Surinam and Peru.

130 references on M&A training: https://www.joriskersten.nl/nl/reviews

Introduction

Within this sequence of blogs I have written three already:

1.    Mergers & Acquisitions done on a “cash & debt free” basis (February 13th 2021):

https://www.dhirubhai.net/pulse/mergers-acquisitions-done-cash-debt-free-basis-kersten-msc-bsc-rab/

2.    Mergers & Acquisitions and the “net debt adjustment” (February 14th 2021):

https://www.dhirubhai.net/pulse/mergers-acquisitions-net-debt-adjustment-joris-kersten-msc-bsc-rab/

3.    The “working capital adjustment” in Mergers & Acquisitions (February 27th 2021):

https://www.dhirubhai.net/pulse/working-capital-adjustment-mergers-acquisitions-kersten-msc-bsc-rab/?trackingId=%2BM1gyE4OS7Knq2j4bbuQcg%3D%3D

And in this blog of today I will talk about setting the “working capital targets” in Mergers & Acquisitions (M&A) !

The working capital analysis

A well built working capital analysis does three things:

·      It helps to define which assets and liabilities should be included in the adjustment;

·      It helps to set a normal level of net working capital;

·      It helps the buyer and the seller to set a “target net working capital”.

Ideally the analysis is done every month, but when data is not available then on a quarterly basis.

And this for a period of at least the past two years, and forward to whatever forecast is available.

Usually for M&A deal purposes there are three things that you want to keep out the net working capital analysis:

·      Cash, debt and incomes taxes in order to not “double count” them;

·      Non-operating assets;

·      Non-operating liabilities.

Let’s look at these three things in more detail.

(Kevin Tomossonie, 2020)

Avoiding double counting

When items like cash, debt and income taxes are left in the working capital to calculate average/ target working capital, then they should NOT be taken up in the “equity bridge”.

In other words, they should then NOT be seen as cash, cash like, debt or debt like items in the equity bridge.

So use items once (!!), so only in the target working capital calculations, or only in the equity bridge.

(Kevin Tomossonie, 2020)

Excluding non-operating assets

Examples of non-operating assets are:

·      Loans receivables from shareholders;

·      Risky short term investments;

·      Personal assets like a prepaid golf club membership.

These assets are NOT part of (operating) working capital, but (potentially) “cash like items” in the deal.

So threat them separate from the (operating) working capital adjustment.

(Kevin Tomossonie, 2020)

Excluding non-operating liabilities

Examples of non-operating liabilities are:

·      Short term loans;

·      Bank borrowings;

·      Financial lease obligations.

These items are debt (or “debt like” items), so they should be defined as debt in the deal.

So they are not forgotten because they are taken up in the “net debt” calculation in the “equity bridge”.

But be careful, there can be a few tricky “cash like” and “debt like” items in the working capital like:

·      Overdue payables to suppliers;

·      Payables to related parties;

·      Deferred revenue.

On the other hand, these items are sometimes seen as part of the working capital, and sometimes seen not as part of the working capital.

Generally depends on which side the corporate finance advisor sits. ??

By the way, when “deferred revenue” is considered a “debt like item”, then only for the amount of OPEX and COGS, think about that ! ??

In my next blog I will talk about how to do the deal technically with a so called “locked box” mechanism !

(Kevin Tomossonie, 2020)

Source used - book: Crushing it as a corporate buyer in the middle market (2020). Kevin Tomossonie. Rock Center Financial Partners, New York.

In the following blog on this topic I will talk about:

·      Locked box mechanism.