The working capital adjustment in a stock purchase agreement can have a direct impact on the price paid for the business. Given that price is arguably the most important variable in a transaction, and that the working capital adjustment can impact price, it follows that the working capital adjustment deserves special attention. (PDF Document)
This adjustment is required because it is impossible to know what a company’s working capital (i.e., generally, current assets minus current liabilities) will be on a future date (specifically the date of the sale). It can take a business anywhere from a couple of weeks to a couple of months to close its books, making this an adjustment that can only take place after the transaction has closed.
Sequence for the Working Capital Adjustment:
On the closing date of the transaction, Buyer will pay to Sellers an initial purchase price, which is subject to an adjustment for working capital (note: additional adjustments can be included, but this post will focus solely on the working capital adjustment). The initial purchase price will include an estimate for working capital for the closing date (Target Working Capital).
Between 60 and 120 days after the closing date, the Buyer will deliver a statement to Sellers with Buyer’s calculation of working capital (Final Working Capital). If all parties agree that the calculation is accurate, then an adjustment will be made as follows.
- If the Final Working Capital is greater than the Target Working Capital (Excess Amount), then Buyer shall pay directly to Sellers an amount equal to the Excess Amount, and Buyer and Sellers shall promptly deliver a joint written instruction letter to the Escrow Agent to release all funds in the Working Capital Escrow Account to Sellers.
- If the Final Working Capital is less than the Target Working Capital (Shortfall Amount), then Buyer and Sellers shall deliver a joint written instruction letter to the Escrow Agent to release an amount equal to the Shortfall Amount from the Working Capital Escrow Account to Buyer.