Working Capital Target in the SPA: Negotiation
How the working capital target is set, negotiated and embedded in the SPA: methodology, key disputes and what TS analysts need to know.
The working capital target is one of the most financially significant items in any Sale and Purchase Agreement. It determines how much net working capital the seller must deliver to the buyer at closing — and whether the buyer receives a price reduction or premium based on the actual NWC at that date. The process of setting and negotiating this target is a core TS activity.
Why the NWC Target Exists
When a buyer acquires a business, they expect to receive the business with a "normal" level of working capital — enough to fund ongoing operations without requiring an immediate cash injection. The NWC target defines what "normal" means.
If actual NWC at closing is above target: the seller has delivered more than expected, and the purchase price increases to compensate.
If actual NWC is below target: the seller has retained value (excess cash) or the business has deteriorated, and the purchase price decreases.
How the Target Is Calculated
The most common methodology is the last twelve months (LTM) average:
- Build monthly NWC for the last 12 months
- Calculate the arithmetic average of all 12 months
- Use that average as the proposed target
This methodology smooths seasonal peaks and troughs and produces a representative "normal" level.
Alternative approaches:
- Specific reference date: NWC at a specific historical balance sheet date (e.g. last year-end)
- Budget-based: NWC at an agreed future date based on a budget (less common, more contentious)
Key Normalisation Steps
Before calculating the target, the NWC history must be normalised:
- Remove non-recurring NWC items (one-off advance payments from customers, one-time supplier prepayments)
- Adjust for structural changes (new business lines, significant customer gains or losses)
- Correct for any accounting anomalies in specific months
The Negotiation Dynamic
The buyer's team argues for a higher target:
"The business requires €5m of NWC to operate normally. We need to ensure we receive that at closing."
The seller's team argues for a lower target:
"The 12-month average overstates what the business actually needs. The business can operate with €4.2m of NWC."
Common disputes:
- The treatment of seasonal spikes in the averaging period
- Whether certain items should be in NWC or in net debt
- The impact of known post-closing changes (new contracts, planned payment term changes)
Practical Tips for FDD Analysts
- Always present the NWC target with both the raw calculation and your normalisation rationale
- Build sensitivity analyses showing the target under different methodologies
- Flag any items where there is material disagreement between the parties early
- Ensure the SPA NWC definition precisely matches the items in your NWC model
Conclusion
The NWC target negotiation is where FDD analysis directly drives deal economics. Analysts who understand the methodology, can defend it under challenge and anticipate the counter-arguments are invaluable in deal negotiations.
The Transaction Services Interview Programme (€119.99, one-time) covers the NWC target in detail, with SPA extracts, Excel models and worked negotiation scenarios. Enrol today.