Net working capital and net debt in M&A
Buyer and seller usually agree an enterprise value: the value of the business as if it had no debt and no spare cash, with a normal level of working capital. The price for the shares, the equity value, follows from it: less net debt and debt-like items, plus or minus the difference between the working capital at closing and the agreed level (the peg).
Net working capital and the peg
Net working capital (NWC) is the capital tied up in the day-to-day business: trade receivables and inventories less trade payables, plus other operating assets and liabilities such as prepayments, accruals and VAT. Cash and financial debt are left out, as they belong to net debt, and so are items outside the operating business.
Working capital moves with the seasons. A year-end figure can be the low or the high of the year, so the peg is usually set on the month-ends of the last twelve months: their average, or a share of revenue. Before that, the month-ends are cleaned of items that will not recur, so the peg reflects normal working capital.
Net debt and debt-like items
Net debt is the financial debt less cash: bank loans, shareholder loans and leases where they are counted, less cash and bank balances. Debt-like items are obligations the buyer will pay after closing that are not financial debt: pension provisions, taxes owed for past years, deferred purchase prices, a restructuring already decided, capital expenditure that was put off. Cash-like items, such as a receivable from the sale of an asset, count the other way.
In Austria the standard KFS/BW 3 defines net debt for the management report: interest-bearing debt, pension and severance provisions included, less liquid funds. A due diligence usually adds further debt-like items.
Locked box and completion accounts
With completion accounts, the price is settled at closing: net debt and working capital are measured at the closing date and the price is adjusted. With a locked box, the price is fixed on a balance sheet drawn up before signing, at the locked-box date. From then on no value may leave the company to the seller beyond what the contract permits. Value that leaves anyway, such as a dividend, a payment to the seller or a waived claim, is leakage, and the seller pays it back.
NWC and net debt in sakto
sakto classes every account for working capital (trade, other or not working capital) and for net debt (cash, debt, debt-like or not net debt), with a default for each balance sheet line that you change account by account. With monthly trial balances, the databook holds NWC and net debt by year and month.
The NWC peg is set on a range of month-ends: their average NWC, NWC as a share of LTM revenue, or a value you enter, with the lowest and highest month-end beside it. A register holds the debt-like, cash-like and NWC cleaning items, each in the buyer's view, the seller's view or agreed.
The equity bridge leads from the enterprise value to the equity value: net debt, debt-like items, the NWC above or below the peg and, for a locked-box deal, the leakage since the locked-box date. The leakage check flags distributions, returns of capital, payments to the seller's side, waived claims, pay and fees to the seller and related parties, and transaction costs; you mark each one.
Questions
What is the NWC peg?
The level of net working capital the price assumes. If the working capital at closing is above the peg, the buyer pays the difference on top; if it is below, the price falls. It is usually set on the month-ends of the last twelve months.
What counts as a debt-like item?
An obligation the buyer pays after closing that is not financial debt: pension provisions, taxes owed for past years, deferred purchase prices, a restructuring already decided, capital expenditure that was put off. What counts is negotiated, so a databook lists each item with its amount.