Over the years we have talked a great deal about due diligence and its importance and impact on deals actually closing. As one of our clients described to me, “The easy part of the M&A process is getting to the letter of intent (LOI). The hard part is once you have the LOI, getting through due diligence…and due diligence was incredibly time consuming.”
His perspective is not unique. Based on post-deal close interviews I have conducted, the sentiments are the same: Be prepared to work really hard for 3-4 months after the LOI.
Today I’m drilling into the due diligence process and looking at one of the many “tests” that buyers are now requiring before a deal actually closes. As you can imagine, as a deal gets closer to completion, buyers need to be assured that the assumptions they have made about the post-close financial picture of the company will be accurate.
To ensure this, since they are usually using your latest quarterly financials as their guide, they often ask for last-minute updates of key financial items to run these tests. One test that is becoming more frequent is called a “net working capital test.”
Here are some actual instructions from a buyer we are dealing with regarding what they will require us to deliver on behalf of our client prior to close:
The Purchase Price contemplates that the Company will deliver working capital at closing to adequately support its operations. Accordingly, the final documentation will include a net working capital test (“NWC Test”) structured with the intent of delivering, at closing, net working capital levels required to support the business in its current form. We contemplate that net working capital will be defined as current assets minus current liabilities of the Company as described in the Company’s financial statements, calculated in accordance with GAAP.
Current assets will include Accounts Receivable, and Other Current Assets. Current liabilities will include Accounts Payable, Accrued Liabilities and Other Current Liabilities. For purposes of the NWC Test, any asset or liability excluded from the Transaction (i.e. cash & equivalents, current maturities of debt, shareholder/related party loans etc.) would, likewise, be excluded from both the NWC Test and the targeted net working capital. The NWC Test would also exclude any accounts related to income taxation or shareholder loans, if any. The NWC Test will be structured as NWC relative to a band of values, with the Purchase Price being reduced on a dollar for dollar basis if NWC is below the targeted band and the Purchase Price being increased on a dollar for dollar basis if NWC is in excess of the targeted band.
OK, two items stand out to me from these specific instructions. First, you can see how important it is to get the data for this test correct because it will have a direct impact on the value paid for your company. If any of the items outlined above are not accurate, and you overstate or understate your NWC, you could be facing a difficult situation post-close.
Secondly, and most importantly (especially if any of these items listed are unclear to you), you really need the guidance of an M&A professional to escort you through due diligence because this is ONLY ONE of many financial tests buyers may perform before closing.
If you are negotiating a deal on your own and you are learning how to do so on the fly, be ready for some hiccups as you work through due diligence and face tests like this one. Although the concept of a NWC test is not hard to fathom, the details of getting it right can be a challenge for many non-CPA business owners.
That is why we encourage business owners who are contemplating an exit event to create a team of M&A professionals to navigate the M&A waters. This not only should include an M&A advisory firm, but we also believe a CPA, an M&A attorney, and a wealth manager are key parts to this crew. This is how Brad Whitlock, an experienced M&A attorney described it to me a few months ago:
Of course M&A transactions close every day having no professional representation on either side of the deal. However, if you want to close a deal with an optimal buyer and have a deal structured that to your advantage, honestly, you will need guidance. Don’t be cheap; hire a team, get help, and allow them to work for you. You have invested too much sweat equity into your business not to do so.
If you are interested in learning more about due diligence and financial tests, please give us a call at 877-213-1792 or provide us with your contact information on our website. We hold complimentary, educational, exit planning seminars throughout North America that are full of great information to help you be prepared for issues like NWC tests.
Carl Doerksen is the Director of Corporate Development at Generational Equity, part of the Generational Group.
© 2016 Generational Equity, LLC. All Rights Reserved.
The information we learn from customers helps us personalize and continually improve your experience. Here are the types of information we gather.
We receive and store any information you enter on our Web site or give us in any other way. We do not sell or rent your personal information to others without your consent. We use the information we collect only for the purposes sending promotional information, enhancing the operation of our site, serving advertisements, for statistical purposes and to administer our systems. We DO NOT use third parties to provide customer service, to serve site content, to serve the advertisements you see on our site, to conduct surveys, to help administer promotional emails, or to administer drawings or contests, but reserve the right to do so in the future without advance notice.
Generational Wealth Advisors’ affiliates are all part of one corporate family, they work with one another and may work together to provide services to you. The sharing of your information among affiliates enables Generational Wealth Advisors to serve you more efficiently and makes it more convenient for you to do business with Generational Group. Generational Wealth Advisors is permitted by law to share information with its affiliates. All of our affiliates follow similar privacy policies.
For reasons such as improving personalization of our service, we might receive information about you from other sources and add it to our account information.
Generational Group may license the use of its intellectual property including but not limited to its name, likeness, and logo for the use of affiliated offices. Such affiliated offices may not be owned, controlled, managed, supervised or staffed by employees, officers, or agents of Generational Group. Affiliated offices may be independently owned and operated. For more information about a particular office, please contact Generational Group at its office in Dallas, Texas.
This page may contain other proprietary notices and copyright information, the terms of which must be observed and followed.
Information on this web site may contain technical inaccuracies or typographical errors. Information may be changed or updated without notice. Generational Group may also make improvements and/or changes in the products and/or the programs described in this information at any time without notice.
Generational Group does not want to receive confidential or proprietary information from you through our web site. Please note that any information or material sent to Generational Group will be deemed NOT to be confidential. By sending Generational Group any information or material, you grant Generational Group an unrestricted, irrevocable license to use, reproduce, display, perform, modify, transmit and distribute those materials or information, and you also agree that Generational Group is free to use any ideas, concepts, know-how or techniques that you send us for any purpose.
Our computer system protects personal information using advanced firewall technology.
Information Generational Group publishes on the World Wide Web may contain references or cross references to other products, programs and services that are not announced or available in your country. Such references do not imply that Generational Group intends to announce such products, programs or services in your country. Consult a Generational Group representative for information regarding the products, programs and services which may be available to you.
Generational Group makes no representations whatsoever about any other web site which you may access through this one. When you access a non-Generational Group web site, please understand that it is independent from Generational Group, and that Generational Group has no control over the content on that web site. In addition, a link to a non-Generational Group web site does not mean that Generational Group endorses or accepts any responsibility for the content, or the use, of such web site. It is up to you to take precautions to ensure that whatever you select for your use is free of such items as viruses, worms, Trojan horses and other items of a destructive nature.
IN NO EVENT WILL Generational Group BE LIABLE TO ANY PARTY OR ANY DIRECT, INDIRECT, SPECIAL OR OTHER CONSEQUENTIAL DAMAGES FOR ANY USE OF THIS WEBSITE, OR ON ANY OTHER HYPERLINKED WEBSITE, INCLUDING, WITHOUT LIMITATION, ANY LOST PROFITS, BUSINESS INTERRUPTION, LOSS OF PROGRAMS OR OTHER DATA ON YOUR INFORMATION HANDLING SYSTEM OR OTHERWISE, EVEN IF WE ARE EXPRESSLY ADVISED OF THE POSSIBILITY OF SUCH DAMAGES.
Furthermore, all information contained within this website is the property of Generational Group.