The Art of Negotiating Working Capital in M&A Transactions

by Kenneth H. Marks and John A. Howard

There are two major elements to the negotiations: agreeing on the working capital target amount, and agreeing on the formula for calculating the actual working capital for the target, at closing and in the true-up. Here are 6 key concepts for formulating a negotiating position.


The selling process for a privately held company has many nuances, including the analysis of the total value of a transaction. For the experienced seller and their team, terms and conditions of the deal can be just as critical as the purchase price. One of those key terms is called the working capital target.

In accounting terms, working capital is equal to current assets minus current liabilities. In middle market M&A transactions (those beyond the small, Main Street asset deals), the selling company is typically expected to deliver a normalized level of working capital (which is defined slightly differently from the accounting definition, as we discuss later) to support the operations of the business post-closing. Calculating the working capital and figuring the basis for the analysis is somewhat of an art and often changes depending upon the norms within a specific industry. Historical trends can be a sound baseline for establishing the target amount. The argument that a buyer can operate the seller’s company with less working capital than the seller is hard to defend without evidence. In growth financings, tightening the working capital cycle can provide a cheap and quickly accessed source of funding. In both M&A and growth financing, optimizing the working capital cycle and assuring efficient use of this capital will increase the value of the business by decreasing or minimizing the capital required to fund the operating cycle. 

Modifying the working capital cycle within a company can touch many aspects of the business. The approach and ability to make these changes depends, in some part, on the relative strategic and competitive strength of the company and the desirability of its products or services. This is where we connect the dots from the discussions above. Typical areas for tightening the working capital cycle include accelerating customer payment or requiring pre-payment, extending supplier credit terms to market norms, increasing inventory turns, and reducing the overall operating or process cycle times. When a seller in an M&A transaction tightens the working capital cycle a number of quarters prior to a sale, he or she demonstrates that the new norm is sustainable. From a buyer’s perspective, this tightened working capital cycle can reduce the risk associated with estimations when negotiating the working capital target.

So, there are two major elements to the negotiations - - agreeing on the working capital target amount, and agreeing on the formula for calculating the actual working capital for the target, at closing and in the true-up. The party that leads this discussion typically has the upper hand in the negotiation.

Below are a few key concepts to think about and consider in formulating a negotiating position -

  1. First, analyze the actual historical monthly working capital; start with the trailing twelve months from the most recent month-end closing. Because most transactions are “Cash Free Debt Free”, cash and funded debt (interest bearing debt) are excluded from the working capital calculation.
  2. If you are on the sell-side of the transaction, look for opportunities to normalize the historical numbers on the balance sheet giving consideration to what the buyer is likely to experience post-closing and accounting for income statement normalizations.  For example, consider excluding certain one-time extended accounts receivable balances if those terms will not exist for the buyer.
  3. If there are extended (or stretched) accounts payable, the amounts of these accounts may look like funded debt to the buyer and become the responsibility of the seller at closing …resulting in reduced cash to the seller. A seller can defend against this claim if the vendor agrees to provide those terms extended terms permanently.
  4. Keep in mind that customer deposits for future work are usually carved-out as an exception to the Cash Free Debt Free concept …the seller is expected to leave cash in the business to cover those amounts. A possible solution to minimize the impact to the Seller of this cash exception, is to look for opportunities to reduce the deposit amounts where there may be work in process that has occurred but not been recognized… and then making the recognition. 
  5. For software or subscription based businesses, start the analysis by excluding deferred revenue. A compromise in the negotiation is to accrue the estimated cost of services in the future needed to support the operational commitment created by having those deferred amounts.
  6. There are three time-based variables that can impact the working capital calculation in some deals: (a) the period used for analyzing and determining the working capital target, (b) the number of days in aging accounts receivable in which the buyer will not recognize the value of invoices, and (c) the number of days in accounts payable that the buyer will consider those invoices as effectively funded debt. For each of these, analyze the numbers in comparison to both historical norms and industry norms to determine opportunities to create an argument for exceptions that will reduce the required level of working capital.

The list above is not meant to be comprehensive, but rather a list of thought provokers to prompt a deeper dive into the working capital terms of a deal. As you might expect, many of these can be flipped and used for the buyer’s advantage to increase the level of required working capital in an M&A transaction for their benefit.


Kenneth H. Marks and John (Buddy) A. Howard are partners of High Rock Partners.