The situation
A Gujarat packaging maker agrees to buy a competitor for an enterprise value of ₹80 crore. The letter of intent says the price assumes a "normal level of working capital". Three months later, at closing, the seller has collected receivables hard and run down stock, so working capital is well below normal. The buyer's advisers say the price should come down. The seller is surprised. Both are right to care.
Why working capital affects the price
Working capital is broadly the money tied up in running the business: receivables plus inventory, less what is owed to suppliers. A buyer pays for a business that can keep operating without extra cash. If the seller collects every receivable and stops buying stock just before closing, the buyer gets a business that needs a cash injection on Day One. The adjustment protects against that, and works both ways: if there is more working capital than normal, the seller is paid more.
How the normal level is set
The usual starting point is an average over the last twelve months, month by month, because many Indian businesses are seasonal. A textile mill may hold far more stock before the festive season than after it. Taking a single year end figure can be badly misleading.
Points to agree early:
- Which items count. Receivables, inventory and payables are standard. Advances, GST input credit, deposits and provisions need a decision.
- How items are valued. Old receivables and slow moving stock should be treated the same way at the reference date and at closing.
- The period for the average. Twelve months is common; a shorter period may suit a growing business.
How the adjustment works at closing
At closing, an estimate of working capital is prepared and the price is adjusted on that basis. Within an agreed period, often sixty to ninety days, final closing accounts are prepared and the difference is settled. The agreement should say who prepares the accounts, how the other side can object, and who decides if they cannot agree, usually an independent accountant.
Where sellers lose money
- Agreeing the "normal level" at a peak month without noticing.
- Leaving definitions vague, so the buyer can argue that some stock is obsolete at closing even though it was valued normally before.
- Not tracking working capital monthly between signing and closing.
Locked box, the alternative
Some deals use a locked box: the price is fixed on a past balance sheet, and the seller promises that no value leaves the business after that date except as agreed. It avoids a closing adjustment but needs reliable accounts and careful rules on leakage.
A short checklist
- Monthly working capital for at least twelve months
- Agreed list of items and how each is valued
- A reference level agreed in the letter of intent or heads of terms
- Closing accounts process and dispute route written into the agreement
- Monthly tracking between signing and closing
Where Synerger fits
Working capital schedules sit in the financial folder of the data room, questions on them go into the question log, and the agreed definitions are linked to the issues list. Enterprise and equity value are set out in valuation methods.
General information; confirm the accounting and tax points with your CA and the drafting with your lawyer.