What is working capital and why does it matter in M&A?

Full Explanation

Imagine acquiring a company with £2M inventory but industry average is £1M. The buyer is paying for excess inventory that is not sustainable. In most M&A deals, target working capital is calculated as: normalised working capital target (agreed by buyer and seller) is established, and the purchase price is adjusted based on actual working capital at close. If target was £3M and actual is £4M, purchase price increases by £1M (buyer pays more because they are assuming more cash needs). Conversely, if actual is £2M, price decreases by £1M. This working capital adjustment protects both sides from surprises. Key working capital drivers: (1) Inventory (days inventory outstanding), (2) Accounts Receivable (days sales outstanding), (3) Accounts Payable (days payable outstanding). For sellers, understanding working capital adjustment mechanics is critical — excess inventory or receivables at close reduce proceeds. For buyers, negotiating a realistic working capital target and implementing it carefully at close protects acquisition return expectations. Post-close, if working capital balances drift away from normalised levels, buyer may claim earnout reductions or seller may claim they've now achieved normalised WC and deserve holdback release.

Related Glossary Terms

Related Questions