In most transactions, the closing balance of the target company—or, in the case of a“carve-out”of business units, the closing balance as of the acquisition date—is of significant importance. This is because, in addition to business planning, it is a key component in determining the purchase price. As the variable component of the closing balance, working capital—alongside net cash on hand—takes center stage. Working capital typically consists of trade receivables, inventory, and other current receivables, less trade payables, current provisions, and other current liabilities.
Since several months may elapse between the time of negotiations, the date the contract is signed, and finally the date control is acquired over the target company, there are various practical methods for determining the purchase price. Under the “locked-box approach,” for example, working capital as of an agreed-upon interim reporting month is used as the basis. As a result, changes in working capital during the period from contract signing to transaction closing have no effect on the purchase price. To provide certainty for both the acquirer and the seller, auditors conduct extensive analyses of the agreed-upon interim financial statements (such as inventory counts), which can tie up significant resources for the acquirer and seller.
Avoiding Disputes
Another option is to include “working capital adjustments” with agreed-upon timeframes in the purchase agreement. The basis for these adjustments is the working capital as of the date the agreement is signed. This allows both the buyer and the seller to adjust the purchase price for a specific period following the transaction, provided that contractually defined conditions are met. The “working capital adjustments” are proposed by the buyer and reviewed by the seller. The more vague their definition in the purchase agreement, the more likely it is that the proposed adjustments will become a point of discussion between the transaction parties. Currency fluctuations also often play a significant role for companies operating internationally.
Closing the Deal Faster
It is important that these and other structuring options—such as contingent purchase price components or variable special payments—be discussed during the contract negotiations between the parties as part of the purchase price determination process and then optimally implemented in the purchase agreement in the best interests of both parties. This prevents protracted purchase price negotiations and, where relevant, also facilitates the precise preparation of a closing balance sheet in accordance with the terms of the purchase agreement between the transaction parties. An auditor with extensive transaction experience can provide valuable assistance in successfully determining the purchase price and in preparing a closing balance sheet.
