What Is Net Working Capital in M&A, and Why Does It Matter for Deal Value?
Table of contents
Net Working Capital (NWC) is a foundational concept in mergers and acquisitions (M&A), directly influencing deal value, negotiations, and post-closing adjustments. Understanding how NWC works can help both buyers and sellers protect their interests and avoid costly surprises.
What Is Net Working Capital?
Net Working Capital is a measure of a company’s short-term operational liquidity. In the context of M&A, it is typically calculated as:
Net Working Capital=Current Assets (excluding cash)−Current Liabilities (excluding debt)\text{Net Working Capital} = \text{Current Assets (excluding cash)} - \text{Current Liabilities (excluding debt)}Net Working Capital=Current Assets (excluding cash)−Current Liabilities (excluding debt)
Common items included:
- Accounts receivable
- Inventory
- Prepaid expenses
- Accounts payable
- Accrued expenses
- Deferred revenue
Items usually excluded:
- Cash and cash equivalents
- Short- and long-term debt
- Related-party receivables/payables
Why Does Net Working Capital Matter in M&A?
1. Ensures Operational Continuity
Buyers want to acquire a business that can operate smoothly from day one. NWC represents the working assets and liabilities needed to keep the business running without an immediate cash infusion.
2. Purchase Price Adjustments
Most M&A deals set a “target” or “peg” for NWC based on historical averages. At closing, the actual NWC is compared to this target:
- If actual NWC is above the target, the seller may receive an upward price adjustment.
- If actual NWC is below the target, the purchase price is reduced.
This mechanism ensures neither party is unfairly advantaged by last-minute changes in working capital.
3. Negotiation Leverage
NWC can represent a significant portion of the purchase price, especially in asset-light or fast-growing businesses. Both sides negotiate what’s included, the calculation method, and the appropriate target, making it a critical point in deal discussions.
4. Prevents Value Manipulation
Without clear NWC terms, sellers might accelerate collections or delay payables before closing to boost cash at the buyer’s expense. Setting a fair NWC target and adjustment process discourages such tactics and keeps the deal equitable.
Best Practices for Startups and Sellers
- Analyze historical NWC trends to set a realistic target.
- Clearly define included/excluded items in the purchase agreement.
- Provide sample calculations to avoid ambiguity.
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Monitor for unusual changes in receivables, payables, or inventory leading up to closing.
Summary Table: Net Working Capital in M&A
| Step | Action |
|---|---|
| Set Target | Agree on NWC “peg” based on historical averages |
| Define Calculation | Specify included/excluded items in the purchase agreement |
| Estimate at Closing | Calculate the estimated NWC at the time of closing |
| Post-Closing Adjustment | Compare actual NWC to target and adjust purchase price as necessary |
| Monitor Manipulation | Watch for last-minute changes that could impact NWC |
Why It Matters
Net Working Capital is more than just a number on the balance sheet, it’s a key driver of deal value, risk allocation, and post-close success. Both buyers and sellers should approach NWC analysis with diligence, transparency, and expert guidance to ensure a fair and smooth transaction.
Want to ensure your M&A deal is structured for success? Kruze Consulting’s experienced team can help you navigate working capital negotiations and optimize your deal value. Contact us for a free consultation.
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