When is a Purchase Price not a Purchase Price?

16th August 2018

When is a Purchase Price not a Purchase Price?
Working Capital and other Adjustments

Working capital is a familiar concept to most business owners but often misunderstood where used in purchase price adjustment mechanisms. It can be an easy way to lose value in a deal if you are not careful.

So what actually is it?

 Working capital is the capital needed to run the activities of a business on a day to day basis, usually calculated as the current operating assets (such as cash, debtors, stock in trade, work in progress) less the current operating liabilities (such as short term debt, accounts payable).

What is a normal level of working capital?

 This is typically the average working capital amount required to generate the earnings upon which the enterprise value (EV) of the purchase offer was based. It is generally set as the target working capital figure for a working capital adjustment.

Often the target working capital is based on the average working capital of the business over the past twelve months. A full year average is usually used because this removes any seasonality effects and because the earnings on which the EV is based are usually measured in the preceding 12 month period.

Why have a working capital adjustment?

Most offers for buying a business are based on an EV of that business and that EV relies on there being a normal level of working capital to be able to generate the earnings needed to support the EV. It is therefore reasonable for a buyer to assume that the seller won’t reduce the working capital below that normal level.

 A working capital adjustment mechanism will therefore prevent a seller from stripping that capital out of the business before completion once the EV has been agreed. If the Seller did this then the Buyer would be required to add further funds in order to ensure that the Company had sufficient working capital to support the EV, effectively increasing the purchase price by the amount of the shortfall.

 If the actual level of working capital exceeds the target level then the buyer has to pay the excess as an uplift in the purchase price. If it is less than the target level then the seller has to repay the shortfall as a price reduction.

Can there be more than one adjustment mechanism?

A working capital adjustment is often used in conjunction with both cash and debt adjustment mechanisms. In these instances offers are made based upon an EV which is tabled on a “cash free, debt free basis and assuming a normal level of working capital”.

Where there are multiple variables, such as in cash free, debt free and normal working capital based deals each part (cash, debt and working capital) is compared against its target figure and the overall adjustment is calculated to determine whether there is an excess to be paid or a shortfall to be repaid. It is however worth noting that where all three adjustment mechanisms are used the parties need to make sure there is no double counting as both cash and debt would ordinarily form part of working capital. A seller or Buyer wouldn’t want to be hit by the same adjustment twice and so it is key to ensure that there is no overlap between them.

Are there any common adjustment pitfalls?

Buyers and sellers can be aggressive with working capital for their own benefit. Examples include:
1. Where the target level is not the true normal level of working capital.

Buyers will want to push for a higher target, sellers will want to push for a lower target. Making “normalization” adjustments for one off or non-recurring working capital items or excluding certain current assets or liabilities will move the target level away from its average.

2. A difference in calculation methods.

This means changing the way working capital is calculated at completion as compared to how it was calculated to determine the target level.

This could be down to how the definitions or the completion accounts processes are drafted in the acquisition agreement. Alternatively it can be done during the preparation of the completion accounts by making subtle changes to matters where individual judgment can be used but where the accountants still keep within the requirements of the acquisition agreement.

Acquisition agreements frequently include a requirement that the completion accounts are prepared in accordance with well understood and accepted accounting principles and standards however these are often only guidelines which are subject to interpretation. It is variances in interpretation that can affect the working capital level.

Parties will often seek to include detailed accounting policies to protect against these differences of interpretation. Worked examples illustrating how working capital should be calculated can be used to give greater certainty over the process.

It is also worth noting that the greater the scope for differences of opinion, the greater the risk of there being a dispute!


 A working capital adjustment mechanism can be an overlooked part of the negotiation process. Whilst it forms part of the acquisition agreement, which is prepared by lawyers, it is more often than not left for accountants or corporate finance advisers to negotiate. Where things fall between two or more stools it not uncommon for mistakes to be made and a well advised buyer or seller can take advantage of this to swing a price adjustment in its favour. The parties therefore need to ensure that their advisers co-ordinate closely on these adjustment mechanisms to reduce the risk of this happening. Failure to do so could result in one of the parties facing an adjustment they were not expecting!

If you would like advice in relation to buying or selling a business or any other company and commercial law matter contact Neil Jones on 01543 431184 or by email at