In a prior edition of Deal Notes®, we discussed the complexities of Working Capital True-Ups which occur post closing of a sale transaction. The potential for controversy and delay in that process can be minimized if a measured approach is taken to developing the Working Capital Target (“WC Target”) that is the foundation for the Working Capital True-up.
The WC Target is an agreed upon figure, typically negotiated late in the sale process. Often it is based on a specified historical monthly average, such as 12 or 36 months. For most aerospace and defense companies that are experiencing modest and consistent growth rates and have stable working capital levels, it often makes little difference which length of the negotiated historical period is chosen for calculating the WC Target.
However, in cases where historical working capital has fluctuated substantially month to month, or where the business is expecting rapid growth in the near future, the WC Target can become a complex and contentious negotiation with substantial financial impact on both the seller and the buyer. In these cases, detailed operating history needs to be evaluated and large fluctuations need to be thoroughly understood, especially as related to Accounts Receivable, Accounts Payable and Inventory. Furthermore, any forecasts produced by the sellers that assume improvements in working capital turn rates must be supported by convincing facts. If deviations are not reasonably defendable, buyers will become skeptical and reduce their bids when the parties enter due diligence and definitive negotiations. At the same time, buyers will want to confirm that the accounting for the historical working capital accounts has been done in accordance with GAAP, including but not limited to all applicable reserves.
Careful preparation and planning is the best means for a seller to minimize the probability of contentious negotiations with a buyer over the calculation of the Working Capital Target. Given this often represents a large amount of money, we strongly recommend that sellers discuss this issue with their accountants, lawyers, and investment bankers, long before they initiate a sale process.
Have a great day everyone.
Kevin Gould
Managing Director, Aerospace
