Purchase Price Adjustments: Setting the Net Working Capital Target

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The working capital adjustment process starts during the pre-acquisition due diligence activities as the company and the buyer examine and negotiate an appropriate level of working capital that is required to fund the company’s normal operations in the post-closing period based on historical trends and future growth needs. This level of working capital is referred to as the “working capital target”. At the time of closing, the company estimates the closing working capital, and it is then compared to the working capital target and the differences are then adjusted either upward (in favor of the company) or downward (in favor of the buyer) to determine a final purchase price at the time of closing. The company’s estimated working capital is then adjusted by the buyer when the buyer has the opportunity and time to true up the estimate, typically within 60 to 90 days after closing.

The working capital target and the mechanics of the purchase price adjustment thus become an important part of the sale process. In order to ensure that the purchase price adjustment works effectively as the parties expect, it is vitally important that the parties are thoughtful and thorough as they set the target. If the target is set either too high or too low, at least one of the parties could be in for a surprise in the form of a large adjustment to the purchase price after the closing. In our experience, an inaccurate working capital target is one of the most common sources of post-closing disputes, or can at a minimum cause hard feelings between the deal parties that often could have been avoided.

The purpose of this paper is to provide our view as to best practices the parties should use in setting the working capital target and pitfalls to avoid. In an ideal scenario, the working capital target will be set so as to minimize the amount of any adjustment and any controversy that could result after a deal closes.

General topics covered include:

  • General Principles to be Applied
  • Relevant Definitional and Documentation Issues
  • Frequent Sources of Dispute
  • Mid-Month Calibration
  • Conclusion

Christopher Letang

Managing Director, Escrow & Payment Solutions and Deputy COO tel:303-957-2855

Chris is the managing director, escrow & payment solutions and deputy COO. In this capacity, Chris manages our relationship manager, relationship associate, and deal intake teams, and works to ensure that our clients are able to navigate the closing and post-closing escrow and payments process as easily as possible.

Chris also has deep expertise in shareholder representation. For over a decade, Chris worked in the SRS Acquiom Professional Services Group where he led the teams that handled post-closing escrow claims, earnouts, purchase price adjustments, distributions of shareholder proceeds and other activities related to serving as shareholder representative.

Before joining SRS Acquiom, Chris practiced corporate law in the Colorado office of Cooley LLP, where he focused on venture capital transactions and mergers and acquisitions. He began his legal career at Cravath, Swaine & Moore LLP in New York City. At Cravath, he primarily represented underwriters in initial public offerings and high-yield debt offerings and lenders in commercial banking transactions.

Chris is a frequent contributor to M&A thought leadership via work on SRS Acquiom’s data studies, articles and speaking presentations. Chris holds a J.D. from Harvard Law School and a B.A. from Rice University.

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