Working Capital Adjustment
A working capital adjustment is a post-closing payment mechanism used in mergers and acquisitions to correct for changes in a company's operating cash between deal signing and closing. When investors buy a business, they expect to receive it with a certain amount of working capital—the difference between current assets and current liabilities. If actual working capital differs from the agreed target, the buyer or seller pays the difference to balance the scales.
Why It Matters for Investors
Working capital adjustments protect angel investors and other buyers from financial surprises after acquisition. Without this mechanism, a seller could strip assets or accumulate liabilities between signing and closing, leaving the buyer with a weakened business. For example, a target company might collect customer payments before closing, reducing accounts receivable and depleting working capital. The adjustment ensures the buyer pays fairly for the company they actually receive, not the one they thought they were getting.
How It Works
During due diligence, buyer and seller agree on a target working capital amount. At closing, actual working capital is calculated. If it's higher than the target, the buyer typically pays the seller the difference. If it's lower, the seller reimburses the buyer. These calculations usually occur 30-60 days after closing once final records are audited.
Practical Example
Imagine an angel investor agrees to buy a software company with a target working capital of $500,000. At closing, actual working capital is only $400,000 because the seller deferred payments to vendors and collected less from customers. The seller would owe the buyer $100,000 as a working capital adjustment.
Related Concepts
Working capital adjustments are a standard protection in angel investing and M&A transactions, helping ensure transparent and fair deal economics.