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Working Capital Adjustments in M&A Transactions

You can deal with risks during M&A if you use the tools for working capital adjustments in m&a transactions and other mechanisms that protect the interests of the buyer, which are described in detail in this article.

How to avoid overpricing when buying a business?

None of the most thorough checks of the acquired company before the conclusion of the M&A transaction guarantees that after a while there will not be found anywhere unreported debt, problems with sales, or taxes.

The owner of the business will do everything possible to inflate its value as much as possible when selling. But even if the time allotted for the transaction is not enough for full-fledged due diligence, the financial director of the purchasing enterprise has every chance to detect a catch and insure against fraud. It is enough to know the common and most popular tricks used by sellers to embellish the real state of affairs in the company, as well as to use universal methods to protect the interests of the buyer.

Judging by practice, most often business owners act quite rationally. Before the sale of the enterprise, they adjust those indicators that directly affect the amount of the transaction. This applies to both the company’s financial results and its assets and liabilities.

What is the working capital adjustment example?

The company’s budget – the objectives of the transaction is the basis for business valuation. The most common mistake at this stage is to take on faith the forecast data provided by the owner, not comparing them with the actual indicators of past periods and current ones.

Determining the market value is a laborious process based on the analysis of many external and internal economic relationships of the property. For the final price of the transaction, an adjustment mechanism can be provided. Such a mechanism would protect the buyer in a situation where the seller tries to withdraw assets while the sale is being negotiated.

To determine the value of the object of assessment within the framework of the comparative approach, the prices of analog objects are adjusted for existing differences in characteristics.

There are the following types of adjustments:

  1. Percentage adjustments are made by multiplying the sales price of an analog object or its unit of comparison by a coefficient reflecting the degree of differences in the characteristics of an analog object and the object being evaluated. If the object being valued is better than a comparable analog, then an increasing coefficient is added to the price of the latter, if it is worse – a decreasing one.
  2. Cash adjustments:
  • absolute adjustments change the price of the sold object-analog as a whole by a certain amount, in which the difference in the characteristics of the object-analog and the object being valued is estimated. A positive adjustment is used if the object being valued is better than a comparable analog, a negative adjustment is used if it is worse;
  • relative adjustments change the price of one unit of comparison by a certain amount, in which differences in characteristics are estimated.

There are several methods for calculating adjustments in the comparative approach: general grouping, methods based on the analysis of paired sales, expert methods, statistical methods.