The Role of Net Working Capital Target in Cash-Free/Debt-Free Deals

In the intricate world of mergers and acquisitions (M&A), where billions of dollars can hinge on precise financial metrics, one concept consistently carries significant weight: the Net Working Capital (NWC) Target. Especially in cash-free, debt-free deals, the NWC Target acts as a key financial checkpoint that balances expectations between buyer and seller.

But what exactly is a Net Working Capital Target, and why does it matter so much in an M&A transaction? In this article, we’ll unpack its definition, explore its components—particularly accrued expenses—and explain how the post-close true-up process helps protect both parties.

What Is a Net Working Capital Target?

The Net Working Capital Target is the negotiated amount of working capital (current assets minus current liabilities) that the buyer expects the business to maintain on the day of closing. It’s used to normalize the working capital position, ensuring the company is neither stripped of its essential resources nor bloated with excess assets.

In cash-free/debt-free deals, the NWC Target essentially acts as a financial baseline—used to determine whether the final purchase price should be adjusted up or down.

Why It Matters:

• Establishes a fair market baseline for working capital at close

• Prevents manipulation of short-term assets or liabilities pre-closing

• Drives transparency and reduces deal friction post-close

Core Components of a Net Working Capital Target

Understanding what makes up the NWC Target helps buyers and sellers prepare more accurately and avoid surprises.

Current Assets

• Accounts Receivable (net of bad debt reserves)

• Inventory (valued at cost or market)

• Prepaid Expenses

• Note: Cash is excluded in a cash-free deal

Current Liabilities

• Accounts Payable

• Accrued Expenses

• Deferred Revenue (in some cases)

These components are typically calculated on a historical average basis—often using a 12-month trailing average to account for seasonality or cyclicality.

The Critical Role of Accrued Expenses

Accrued expenses refer to liabilities a company has incurred but has not yet paid. These might include:

• Employee salaries and bonuses

• Rent and utilities

• Professional fees

• Taxes payable

During due diligence, accrued expenses are scrutinized heavily, because underestimating them can artificially inflate working capital and create a post-close dispute. Buyers want to ensure these liabilities are accurately reflected in the NWC calculation so they don’t inherit unexpected obligations after the deal closes.

The Post-Close True-Up Process (Typically Within 90 Days)

Once the transaction closes, there’s often a true-up period, generally lasting 60–90 days, during which the actual working capital at closing is measured against the agreed-upon NWC Target.

Example:

Let’s say the target was $100,000. Upon final accounting, the actual working capital at closing is $200,000. In this case, the seller may receive an additional $100,000—reflecting the surplus.

Conversely, if the actual working capital falls short (e.g., $70,000), the seller would owe the buyer a $30,000 reduction in purchase price.

This true-up mechanism keeps the transaction equitable and honest, protecting both parties from last-minute manipulations or miscalculations.

Strategies to Improve Working Capital Before a Sale

Many sellers overlook the importance of proactively optimizing working capital well in advance of going to market. By improving processes related to accounts receivable, inventory turnover, and vendor payment terms, sellers can:

• Boost their working capital balance at closing

• Reduce deductions from the purchase price

• Keep more cash in their pocket post-close

This is where working with a transaction-savvy advisor can make a seven-figure difference, particularly in middle-market and larger transactions.

Key Takeaways for Buyers and Sellers

• The Net Working Capital Target is not a fixed number—it’s the result of negotiation and historical performance.

• Accurate financial records and timely closing balance sheets are essential for a smooth true-up process.

• The NWC true-up helps ensure that buyers receive a business that can operate without needing immediate capital infusion.

• Sellers should conduct a pre-sale financial tune-up to ensure their working capital profile aligns with buyer expectations.

Final Thoughts

Whether you’re preparing to sell your company or considering a strategic acquisition, understanding the nuances of the Net Working Capital Target can help avoid valuation disputes and keep your transaction on solid footing. The interplay between current assets, liabilities, and accrued expenses—along with a well-executed true-up—forms the foundation of fairness in cash-free/debt-free M&A deals.

If you’re thinking of selling in the next 12–36 months, it’s never too early to evaluate your working capital profile. Early planning could result in significant gains when it’s time to close the deal.

Contact us to learn proven strategies to improve your working capital position and maximize your exit value.