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WORKING CAPITAL ADJUSTMENT - Business Purchase Agreement

 Business Purchase  -  Letter of Intent  -  Due Diligence  -  Negotiations  -  Asset vs Share  -  Purchase Agreement  -  Closing

Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

A working capital adjustment in a business purchase is a mechanism that adjusts the final purchase price to account for the actual level of working capital delivered by the seller at the time the deal closes, compared to an agreed-upon target level. Working capital is generally defined as Current Assets minus Current Liabilities (excluding cash and debt in a typical merger and acquisition context).

The adjustment ensures the buyer receives an amount of short-term operating funds sufficient to run the business immediately after closing without having to inject extra cash. The process typically proceeds in the following manner:

  1. Set a Target: The buyer and seller agree on a Target Working Capital level (often based on a historical average of the business's working capital needs) that the business is expected to have at closing.

  2. Calculate Actual: After the closing date (typically 60 to 90 days later), the Actual Working Capital of the business on the closing date is calculated.

  3. Adjust the Price:

    • If Actual Working Capital > Target Working Capital: The purchase price is increased by the difference, meaning the buyer pays the seller the excess amount.

    • If Actual Working Capital < Target Working Capital: The purchase price is decreased by the difference, meaning the seller pays the buyer (or the amount is released from escrow) to cover the shortfall.

The working capital adjustment is critical for achieving a fair valuation and a smooth post-closing transition for several reasons:

  • Ensures Sufficient Liquidity: It guarantees the buyer receives a business with enough "gas in the tank" (i.e., operating liquidity like collectible accounts receivable and inventory) to continue day-to-day operations and meet short-term obligations (like paying accounts payable) without disruption or the need for an immediate capital infusion.

  • Prevents Value Manipulation: It discourages the seller from engaging in last-minute actions to artificially inflate their cash balance (which is usually kept by the seller in a "cash-free, debt-free" deal structure) at the expense of working capital. For example, a seller might delay paying vendors (increasing Accounts Payable, thus decreasing working capital) or aggressively collect receivables just before closing.

  • Fair Compensation for Fluctuations: It acts as a true-up for the purchase price. The initial price is negotiated months before closing, and it assumes a normal, agreed-upon level of working capital. The adjustment ensures both parties are fairly compensated if the actual working capital fluctuates due to normal business activity or other changes between the negotiation date and the closing date.

A well-drafted business purchase agreement is the foundation of a successful acquisition. It should be a robust document that protects the buyer from future surprises and gives them clear remedies if the business is not as it was represented. For knowledgeable and experienced legal representation when purchasing a business, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.

 

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