Working capital in M&A transactions

In M&A transactions the focus is on the price, but a significant part of the value that actually changes hands hinges on a less visible issue: working capital. Many deals settle on a price that is then adjusted based on the working capital delivered at closing. Anyone who fails to grasp this mechanism risks discovering, once the deal is done, that they have received or paid thousands of francs less or more than expected.

What working capital is

Net working capital is, in simplified terms, the difference between current assets and current liabilities tied to operations:

Assets: trade receivables, inventory, advances to suppliers.
Liabilities: trade payables, customer prepayments, other short-term operating liabilities.

It represents the capital tied up in keeping the business running day to day. A company that sells on 60-day terms but pays its suppliers within 30 needs cash to bridge the gap: that cash is, in effect, working capital.

Why it matters in an acquisition

Almost all SME transactions are structured on a cash-free / debt-free basis: the seller hands over the business without excess liquidity and without financial debt, which are settled separately. But the company must reach the buyer with enough working capital to operate normally. If, before closing, the seller rushes to collect receivables, runs down inventory and delays supplier payments, they hand over a “drained” business: the buyer will have to inject cash the very next day to keep it going. The adjustment mechanism exists precisely to prevent such manoeuvres.

The “normal” level (target)

The heart of the negotiation is defining a normal level of working capital, the so-called target or peg. It is usually calculated as an average of the last 12 months, to neutralise seasonality. The principle: the agreed price assumes the company is delivered with that level of working capital.

At closing, the actual working capital is captured and compared with the target:

Working capital above target → the seller left more operating capital → the buyer pays a top-up.
Working capital below target → the seller delivered less → the price drops.

This way no one gains or loses depending on the timing of the closing.

The adjustment mechanism

In practice two main approaches are used:

Completion accounts: at closing a provisional adjustment is estimated; a few weeks later the definitive accounts as at the closing date are prepared and the difference is settled. Precise but capable of generating disputes.
Locked box: a past reference date is fixed, the balance sheet is “sealed” as at that date, and the buyer takes on performance up to closing, with a ban on value withdrawals in the seller’s favour (leakage). Simpler and with fewer subsequent disputes, widely used in Europe.

The choice depends on the quality of the accounting data and the trust between the parties.

The most common pitfalls

Ambiguous definition: if it is unclear what is and is not included in working capital (taxes, accruals, one-off items), the adjustment becomes a battlefield. The definition must be written precisely in the contract.
Ignored seasonality: a target based on a peak or trough month distorts the calculation. The 12-month average serves this purpose.
Uncollectible receivables in the target: if working capital includes receivables that will never be collected, the buyer is paying for an asset that does not exist. Due diligence must verify their quality.
Overvalued inventory: obsolete or unsellable goods booked at full value inflate the delivered working capital.
Pre-closing manoeuvres: accelerating collections and slowing payments to flatter cash at the expense of working capital. The target mechanism neutralises this, if well drafted.

In summary

Working capital is the operating capital a company must hold to function.
Cash-free / debt-free transactions assume a “normal” level of working capital at delivery.
A target is set (12-month average) and the price is adjusted for the difference at closing.
Locked box and completion accounts are the two typical mechanisms.
A precise definition, control over the quality of receivables and inventory, and avoiding pre-closing manoeuvres are decisive.

How we help you

We support buyers and sellers in M&A transactions involving Swiss SMEs: defining the working capital target, adjustment mechanisms, due diligence on receivables and inventory, and contractual clauses that avoid surprises at closing. Let’s talk about your deal.