After months of negotiations have resulted in an agreement on purchase price, it’s easy to think that everything important has been decided in an M&A transaction. But that’s not the case. In my career, I have routinely found that many key terms involved in a deal between buyer and seller often come as a surprise to bootstrapping entrepreneurs.
As a deal gets into serious due diligence, bankers and lawyers begin to circulate drafts of definitive deal documents. The documents are dense. So it’s easy to miss that many critical issues are still in play. Given that many of these terms can have a material – if seemingly subtle – impact on the overall attractiveness of a deal, I firmly believe that at least a high-level understanding of key terms should be reached by owner-operating sellers before they engage in crucial transaction negotiations. Some of the term-focused, transaction-oriented content in this blog will be my attempt to prepare potential sellers for some of the key issues that they will almost certainly encounter when they eventually pursue a transaction.
My first handful of Agility Growth blog posts will deal with one of the most common mechanisms used to adjust the “face value” price of a deal: the net working capital adjustment. Defined as current assets minus current liabilities, working capital is a measure of a company’s efficiency as well as its short-term financial health. Whether a company is managing working capital efficiently is usually a fairly innocuous issue tackled during due diligence for software, mobile, and Internet technology companies, since a buyer can manage working capital however it wishes post transaction. However, the purchase price impact of a buyer’s “target working capital balance” at close vs. the company’s actual working capital at close is not necessarily as innocuous, particularly under certain circumstances.
In my next post, I will kick off the net working capital adjustment conversation with a fundamental analysis of buyer/seller interests in managing and adjusting working capital targets. I will also introduce some of the common issues and pitfalls that sellers (and in some circumstances, buyers) can run into when negotiating a working capital adjustment. One particular issue that we will cover in Part III of the series, the impact of deferred (unearned) revenue in working capital adjustments, has been particularly important to each of buyer and seller in a number of my previously closed transactions. Please let us know if there are other components of working capital that you would like me to discuss in future posts.
In the future, I will address other key terms in a transaction such as representations and warranties, escrow, and indemnification. These terms might appear legal and mundane, but they actually have important business ramifications that every entrepreneur should understand.