Steve Plaskitt' Head of Corporate Finance at MHA Tait Walker gives his views on how working capital impacts deal valuations especially since the Pandemic began.
As every SME company owner knows managing cash and your working capital is critical to keeping your business running. “Cash is King” – it was before the Pandemic’ and it still is afterwards. But when it comes to deals and valuations of companies how much Cash needs to be kept for working capital? And given the most recent two-year period how you do know what a normal amount is especially when the last two years trading have been anything but normal?
The valuation of a company is not simply the valuation of the business
In simple terms’ the valuation of a company is the valuation of the business (typically a multiple of its maintainable profits) plus the excess cash that it has at the time of the sale less the debt that it has. Other than an overdraft or invoice finance’ most of the debt in a SME is long term debt and doesn’t move significantly from week to week in the company.
Excess Cash is not easily defined
Cash moves daily as receipts come in and payments are made; it will fluctuate with regularity within each month e.g.’ when HMRC is paid mid-month or when salaries are paid at the end of the month; and it will move cyclically within each year e.g.’ due to seasonality of sales. So’ when it comes to define excess cash in a deal’ there is always a debate about what the level of excess cash is and how much money is required to manage the working capital of stock’ debtors’ and creditors.
Too often this issue is not dealt with early during a deal process and is not fully addressed in heads of terms. This can lead to substantial changes in the expected value of a deal from the vendor’s perspective’ or in extreme cases’ of deals collapsing later when neither the seller nor the buyer can agree on what is the suitable valuation adjustment.
You need to appoint a Corporate Finance Adviser to investigate greater detail and assess how the current trading and historic balance sheets could show a normalised working capital and cash position.
There is no set way to defining excess cash or normalised working capital adjustments – though some serial buyers may have their own preferred ways’ as would their corporate finance advisers. At MHA Tait Walker Corporate Finance’ our team is very experienced at deal handling and negotiation’ and we have invested significantly in our data analytics and due diligence capabilities so we can advise both buyers and sellers from all perspectives.
Agreeing on the final valuation impact towards the end of a deal process becomes part of the final points of negotiation. Often this is when emotions are running higher’ and it is being negotiated along with many legal matters which will have arisen during the due diligence period. Even before the valuation adjustments are known’ there needs to be a decision about exactly what legal mechanism will be used in the final share purchase agreement.
Due to the Pandemic’ working capital patterns will have changed for many businesses and so negotiating excess cash and normal working capital positions in the final valuation impact is increasingly both an art and a science – the art of negotiation meeting the science of data analysis in due diligence.
