The net working capital (NWC) target is a predetermined level of net working capital that is agreed upon by the buyer and seller in an acquisition or merger. It serves as a reference point against which the actual NWC at the time of closing is compared to determine any purchase price adjustments.
Here's a short example of how the NWC target works in an acquisition:
- Company A is acquiring Startup B, and they agree on a purchase price of $10 million.
- As part of the acquisition agreement, they set an NWC target at $2 million. This means that Startup B should have $2 million of net working capital at the time of closing for the deal to proceed as planned.
- Prior to the closing date, Startup B's financial statements are prepared, and the actual NWC is calculated to be $2.5 million.
- Since the actual NWC of $2.5 million is higher than the agreed-upon target of $2 million, the purchase price is adjusted. Company A will now pay $10 million + ($2.5 million - $2 million) = $10.5 million to acquire Startup B.
In this example, the higher NWC for Startup B led to an upward adjustment to the purchase price since it exceeded the NWC target.