We covered what it means for a transaction to be cash-free, debt-free (see this post) and what it means to set the right net working capital peg (see this post). Today, we chat through the final stage — the completion accounts mechanism.
You see, at closing of a transaction, the seller will estimate their net working capital (NWC). Why? Because the transaction will close on a relatively random day when all the accounts aren’t completely tied out. So based on that estimate and the peg that has been decided, the transaction proceeds will be distributed. Because this is an estimate, there needs to be a true-up mechanism to provide the actual values — this is the completion accounts mechanism.
If you haven’t read the prior post on the NWC peg, start there — the math below builds directly on it. Shortly after closing (usually 60-90 days), financial statements will be provided to adjust the purchase price based on the actual financial position of the business at the closing date. These adjustments will relate to NWC, cash (recall in M&A context, cash is excluded from NWC), debt, and any other key financial metrics stipulated in the purchase agreement. The primary concern and one that is most likely to fluctuate is the NWC. For example, your estimated NWC is $12, and the peg is $10, so at closing you receive $2. Now at the true-up, the actual NWC turns out to be $9, so you must return $3 to the buyer.
As you’d expect, people don’t like dealing with these post-closing gymnastics. No seller wants to be returning capital, and no buyer wants to be paying more. So to cut the stalemate of arg-greeing — arguing to win every point when agreeing that everybody wants the deal — there are several tactics to deploy to get the deal done. First, there is the dollar-for-dollar adjustment as described in the numerical example above. While makes good sense, it is mechanically difficult because who wants to chase individual shareholders after the close to get the true-up.
To avoid this, purchase agreements include a NWC adjustment escrow to efficiently cover any of these swings. This adjustment escrow is often determined as a percentage of transaction value (e.g., 1% of transaction value, but in larger deals it will usually be much lower than that). Suppose your proceeds are $100. With an adjustment escrow, you would receive $99 at close and then the $1 would be used to cover any NWC variances at the time of adjustment. If no variances arise, you end up receiving the full $1 post-close.
Now as a seller, you want to keep these escrows minimal. The time value of money — today is always better than tomorrow. And you don’t want to give undue leverage to the buyer. So the arg-greeing continues… What can you do to break up this stalemate? Enter the NWC collar. You agree to a reasonable level of fluctuation in NWC (say 1–2% of the NWC peg). For example, if the peg is $100 and the collar is 2%, the parties assume that NWC fluctuates between $98–102. And if at the time of true-up, the NWC ends up being $101, no adjustment is needed. If it ends up being $103, the seller is owed an additional $1.
And finally, any remaining disputes are resolved by appointing a neutral third party — typically an accounting firm — to review the completion accounts and make a final determination. How the cost of this review gets allocated is itself a negotiated point. The most common approaches are
- A proportional split where fees are allocated based on how much of the disputed amount was resolved in each party’s favor;
- Full responsibility on the losing party whose position was rejected; or
- A clean 50/50 split regardless of outcome.
Once the right neutral party is in place, this stage tends to resolve cleanly and quickly.
With completion accounts understood, you now have the full picture of how NWC impacts transaction proceeds.