The adjustment is often made on a dollar-for-dollar basis.In the example above, with a hurdle of m, if the seller delivers only .5m of working capital, the purchase price would be adjusted to .5m.
A hurdle increases the likelihood that the buyer will obtain the expected relationships in addition to the expected cash flows.Calculating the working-capital hurdle The most common method for calculating a hurdle is based on the average monthly adjusted working capital over a 12-month period.The need for working-capital hurdles A working-capital hurdle is intended to ensure that the buyer receives the expected mix of assets and liabilities (that is, the company’s normal working capital needed to run the business) in the transaction.It’s possible to change the mix of current assets and liabilities without affecting income and EBITDA so that a seller could maintain its EBITDA but not deliver the promised mix.A working-capital hurdle protects the buyer by reducing the purchase price to the extent the above actions reduce the amount of working capital delivered.
At the same time, the seller receives a higher purchase price for delivering working capital above the hurdle.
In most M&A transactions, the parties arrive at the purchase price by multiplying the target company’s earnings before interest, taxes, depreciation, and amortisation (EBITDA) by an agreed-upon multiple.
Before a deal closes, however, a seller can juggle the company’s assets and liabilities in ways that reduce the company’s future cash flows without affecting its EBITDA or, in turn, the purchase price.
A working-capital hurdle also will help the buyer deal with less egregious issues that can affect a deal’s bottom line.
Consider, for example, a target company that does not maintain an accounts-receivable allowance for bad debt.
Conversely, if the seller delivers .5m, the price would become .5m.