Working capital is a critical concept in the context of asset purchase and sale agreements (APAs) and stock purchase and sale agreements (SPAs), as it directly impacts the purchase price and ensures the financial stability of the acquired business during the transition. In these agreements, working capital is generally defined as the difference between current assets and current liabilities, calculated in accordance with Generally Accepted Accounting Principles (GAAP) or other agreed-upon accounting standards.
In an APA or SPA, working capital adjustments are often included to account for changes in the target company’s financial position between the signing of the agreement and the closing of the transaction. These adjustments ensure that the buyer receives a business with a consistent level of working capital, as agreed upon in the purchase agreement. For instance, the agreements typically establish a “target working capital” or “peg,” which is based on the target company’s historical financial statements. At closing, the actual working capital is compared to this target, and the purchase price is adjusted accordingly. If the actual working capital exceeds the target, the purchase price increases; if it falls short, the purchase price decreases.
The calculation of working capital and its adjustments can vary depending on the specific terms of the agreement. For example, in the Chicago Bridge v. Westinghouse case, a 2017 decision from the Delaware Supreme Court, the court emphasized that working capital calculations must adhere to the accounting principles and methodologies historically used by the seller, as specified in the purchase agreement. This ensures consistency and avoids disputes over accounting practices
In Chicago Bridge, the manner of calculating net working capital was directly at issue. A few days before closing the Seller calculated net working capital at over $428 million more than the target net working capital, but that calculation was inconsistent with GAAP. After closing, during the true-up period, the Buyer calculated net working capital consistent with GAAP at $2 billion less than the target. Not surprisingly, litigation ensued. The trial court agreed with the Buyer, but the Delaware Supreme Court reversed and agreed with the Seller.
Working capital adjustments also serve to protect the buyer from potential manipulation of financial metrics by the seller. For example, sellers might accelerate the collection of receivables or delay the payment of liabilities to inflate working capital. A well-drafted agreement mitigates such risks by specifying the accounting principles to be used and providing mechanisms for post-closing adjustments and dispute resolution.
In conclusion, working capital plays a pivotal role in APAs and SPAs, ensuring a fair transaction by aligning the financial expectations of both parties. Clear definitions, adherence to agreed-upon accounting standards, and robust adjustment mechanisms are essential to avoid disputes and ensure a smooth transition of the business.
Beresford Booth’s Business, Mergers and Acquisitions Group regularly counsels buyers and sellers in all aspects of asset purchase and stock purchase agreements that include working capital adjustment provisions. We would be pleased to help you with your transaction. Please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.