Most all aerospace and defense M&A transaction documents include a provision for a “Working Capital True-up”. To those unfamiliar with stock/asset purchase agreements, this may seem like a complex legal construct riddled with sophisticated accounting concepts. And while the technical mechanics can be highly complex, conceptually this is a very simple provision.
Working Capital True-ups set forth an agreed amount of working capital to be transferred to the buyer at closing. Without a Working Capital True-up, there would be nothing preventing a seller from accelerating accounts receivable collections or delaying the payments to suppliers in the weeks prior to closing. Such actions, unchecked, would greatly benefit the seller at a dollar-to-dollar expense to the buyer. With a Working Capital True-up in place, such actions would result in a dollar-for-dollar reduction of the purchase price, thereby removing any incentive for such action by the seller. With a Working Capital True-up in place, the buyer is assured they will receive exactly what the seller has agreed to deliver on the closing date, as related to such important and fluid accounts as accounts receivable, inventory, accounts payable and accrued expenses.
Over the past 21-years, we have seen working capital to be the most common area for controversy, post-closing. By specifying exactly how much working capital will be delivered on the closing date, and exactly how these amounts will be calculated, buyers and sellers are able to minimize the level of post-closing controversy. And while Accounts receivable and accounts payable are relatively easy to confirm and schedule, accounts like Inventory can be extremely difficult to define in transaction documents. A few example questions are: i) should inventory in excess of three-years’ usage be deemed obsolete? and ii) should inventory older than four-years be deemed obsolete?
While a Working Capital True-up is a simple concept, it can be extremely difficult to clearly document exactly what the seller is agreeing to deliver to the buyer on the closing date, which can lead to post-closing controversies. However, thorough careful preparation well in advance of starting a sale process, a seller can optimally prepare for complying with a Working Capital True-up, which should result in the avoidance of post-sale controversy with the buyer.
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