When buyers and sellers sit down to negotiate the purchase of a business, the focus often falls squarely on the purchase price. However, seasoned business lawyers know that what matters just as much, if not more, is what lies beneath that number. One of the most important tools for protecting deal value is the Target Working Capital (TWC) adjustment, the fuel gauge that ensures the engine of the business keeps running after the keys change hands.
Don’t navigate this complex process alone. Contact the experienced business lawyers at MBM Law today to ensure your acquisition is protected.
What is Working Capital?
In mergers and acquisitions (M&A), business lawyers clarify that a fair working capital benchmark ensures buyers acquire a business with sufficient funds for seamless operations post-closing.
At its core, working capital measures a company’s short-term liquidity, the financial fuel that keeps the business moving. It’s the difference between current assets, e.g., receivables and inventory, and current liabilities, such as payables and accrued expenses.
In a sale, it functions as a snapshot of what funds are needed to keep the business running after closing. Buyers expect that when acquiring a new business, there will be enough capital tied up in these accounts to operate smoothly. Sellers, on the other hand, have every incentive to pull as much money out prior to closing, perhaps by accelerating collections or delaying payments before closing.
Without a clear agreement on working capital, buyers could find themselves stalled at closing and needing more capital to keep operating. Ensure a smooth transition by having a clear working capital agreement in place. Our business lawyers can help you get started.
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How to Calculate and Structure a TWC Clause
This is where a well-crafted Target Working Capital provision comes into play. It sets the baseline amount of working capital the seller must deliver when handing over the keys. After the deal closes, the buyer assesses if the actual working capital at closing matches the agreed-upon amount. If it’s below the target, the buyer gets a price reduction, dollar-for-dollar. If there’s more capital in the tank, the seller may be entitled to a supplemental payment at closing reflecting the surplus cash in the accounts.
Arriving at the right target is as much art as science. Business lawyers assist clients in establishing the TWC by reviewing historical working capital balances, and checking past levels over a meaningful period (often 12 months) to identify the average level needed for ordinary operations. This approach helps smooth out seasonal swings and anomalies. For seasonal businesses, buyers focus on comparable periods from prior years, instead of a simple trailing average.
Alternatively, some deals take a point-in-time snapshot, like the most recent quarter-end balance. While easier to calculate, this method can create risks if the chosen date doesn’t represent typical levels. Others set a fixed target, negotiated based on forecasts or specific operational needs, which simplifies closing mechanics but requires high confidence in the chosen figure.
Defining Working Capital: What Accounts Are Included?
Just as with any high-performance engine, clarity matters when defining which accounts count toward working capital. Cash and debt are typically parked separately, handled elsewhere through “cash free, debt free” purchase price adjustments.
Experienced business lawyers distinguish between operational accounts: receivables, inventory, and payables from cash and debt. Buyers should scrutinize these accounts during diligence, watching for irregularities that could skew historical averages—such as one-off transactions, temporary cost-cutting measures, or pandemic-related distortions.
Protecting Clients with Post-Closing Working Capital True-Ups
Target Working Capital adjustments rarely stand alone; they come with a post-closing true-up mechanism, measuring what’s actually in the tank versus the promised amount. Business lawyers include post-closing true-up mechanisms in the transaction documents. This protects buyers from sellers who might run the engine on fumes pre-closing and ensures incentives stay aligned all the way to the finish line.
The cost of missing this adjustment cannot be overstated: buyers who inherit a business running on “EMPTY” might face immediate cash infusions, damaged vendor relationships, and derailed strategic plans. Addressing TWC early in the process before signing the purchase agreement gives buyers leverage to set expectations and avoid post-closing surprises.
Business lawyers and transaction attorneys are indispensable throughout the Target Working Capital negotiation. Their expertise includes:
- Analyzing capital trends and industry standards
- Identifying red flags, and potential risks during due diligence
- Crafting clear legal language to avoid future breakdowns over which accounts are counted.
Most importantly, they ensure the TWC adjustment works in harmony with other critical deal terms, avoiding trouble in the future.
MBM Law: Your Partner for a Successful Business Acquisition
In the end, Target Working Capital isn’t just a line item for accountants, it’s the fuel that keeps your new business firing on all cylinders from day one. Skipping careful negotiations could turn a promising acquisition into a roadside emergency.
The Business Law team at MBM Law specializes in advising clients on all aspects of Target Working Capital during business acquisitions, from analyzing financial trends, to negotiating and drafting airtight provisions.
Ready to protect your deal? Our team is here to help.
