You're heading for an M&A transaction and your company has a lot of cash. The balance sheet is strong. Thats good, right? Yes, but unless you want to hand that cash to the acquirer or give the tax man an extra large chunk, youd better plan ahead.
One way to keep excess cash is to distribute it in advance of an M&A transaction. The negative is that a higher tax rate may apply to cash distributions. Alternatively, you could negotiate a dollar for dollar price adjustment upward for excess cash left in the company at the time of acquisition. This could permit shareholders to receive more favorable capital gains treatment.
If the acquirer buys the stock of your company, they get everything the company owns, including cash in your bank accounts. Sellers are expected to deliver a company with adequate working capital, so dont expect to pull out all the cash, but you also dont want to give away excess cash. So incorporate an excess working capital adjustment into your price negotiations.
The simplest computation of net working capital is current assets less current liabilities. The amount of required net working capital varies and will depend on a companys cash flow characteristics. For software companies, deferred revenue presents some challenges in computing working capital. With an accountants help calculate working capital required to continue business as usual, including near term growth; then determine the cash component of working capital. All cash beyond that should be yours to keep, including excess cash generated between the time a purchase price is negotiated and when the transaction actually closes.
Financial statements you provide prior to price negotiations create the basis for the buyers financial expectations and can be used as a reference point for price adjustments based on net working capital changes. So dont deliver financial statements without understanding what they will indicate to the buyer.
Most importantly, communicate clearly with the buyer about your expectations regarding excess cash, and do it in writing. For example, you could add a note to financial statements identifying the amount of excess cash and indicating that excess cash will not go with the business. It is especially important that the Letter of Intent address the formula for computing excess cash, the expectation of both buyer and seller for the amount of net working capital at closing, and the mechanism for dealing with any amounts over or under the target amount.
A version of this article originally appeared in Soft?letter and Software Success.