Plan to Tie Up Loose Ends after an M&A Closing
Closing a deal really doesn’t mean the deal is completely closed on closing day. That’s a reality of M&A. In most deals, Buyer and Seller have little bit of work to conduct after the deal closes.
Allow time to fully close the books
Although the deal is closed as of the closing date, a company can’t produce an accurate balance sheet on that very day. Depending on the business, 30 to 90 days are necessary to fully close the books. For that reason, the closing uses an estimated balance sheet.
At some agreed upon post-closing date, the parties make adjustments to that closing day balance sheet based on the fully closed books. In some cases, Buyer pays more, and in other cases Seller receives less. Often, this adjustment is made to the money in escrow.
Schedule a working capital adjustment
Most purchase agreements include an adjustment for working capital. Prior to closing the deal, Buyer and Seller agree to the amount of working capital that Buyer is purchasing.
Working capital is the difference between assets that can quickly be converted into cash (accounts receivable, inventory, and prepaid expenses) and the bills that are due immediately (accounts payable, wages payable, interest accrued, and unpaid liabilities). Think of working capital as being the same thing as cash.
At closing day, the parties adjust the purchase price based on the amount of the company’s working capital. Working capital adjustments help prevent a Seller from simply not paying bills prior to closing; cash belongs to the Seller, so he may be inclined to sell off inventory and accounts receivable and stop paying bills in order to generate cash.
In that scenario, the Buyer assumes a business with huge debts at closing. For example, if both sides agree working capital should be $1 million at the closing date but the closing day balance sheet shows $1.2 million in working capital, the Buyer pays the seller an extra $200,000 at closing.
If the Buyer has to pay more at closing, it’s because she’s purchasing more cash. Say you agree to buy a car for $5,000. Would you be willing to pay $5,100 if that car also included a $100 bill on the dashboard? The net expense to you is the same, $5,000. The same principle applies to a working capital adjustment.