Transform Working Capital in M&A with Virtual CFO Services

Mergers and Acquisitions are strategic measures for businesses wanting to grow, consolidate business, or enter a new marketplace. However, one aspect that can determine the failure or success of an M&A deal is working capital management. 

As per EY's 2022 report in India for the year 2022, 41% of M&A deals faced the issue of financial integration, thereby emphasizing that proper attention to working capital management throughout the entire transaction process is crucial. Effective working capital management can ensure proper liquidity, successful operational integration, and, in extension, success in M&A deals.

This blog will discuss the importance of working capital management in M&A, its influence on the outcome of the deal, and how virtual CFO services could provide major support in managing working capital in the process of such intricate transactions.

Challenges Businesses Face During M&A

Managing working capital during mergers and acquisitions presents unique challenges that can significantly impact the success of a transaction. Here are the key hurdles businesses often encounter:

1. Uncertainty in Working Capital Adjustments

• Determining the right level of working capital is complex and often leads to disputes between buyers and sellers. Misalignment can result in unexpected post-deal adjustments, impacting the purchase price and cash flow.

2. Seasonality and Historical Trends

• Businesses with fluctuating demand cycles, such as construction or retail, struggle to establish accurate working capital targets. Ignoring historical trends can lead to liquidity gaps during integration.

3. Balancing Current and Long-Term Liabilities

• Managing short-term liabilities like accounts payable and accrued expenses while planning for long-term operational needs is challenging, especially when financial integration is rushed.

4. Operational Integration Risks

• Combining two companies' financial structures often disrupts cash flow, leading to inefficiencies in revenue collection and delays in payments to suppliers, which can stall business operations.

These challenges highlight why working capital management is critical for M&A success. Addressing these hurdles proactively ensures smooth transitions and protects the financial health of both entities.

Why is Working Capital Management Crucial in M&A?

Working capital management forms the backbone of M&A. It affects everything from target company valuations to operational continuity and post-deal success levels of the combined entity. In other words, working capital is a mechanism balancing current assets with cash and cash equivalents, accounts receivable, and inventory on one side versus current liabilities in accounts payable and short-term debt. 

Proper management will ensure that the company has enough liquidity so that short-term obligations can be met, thus forming a big necessity for the smooth continuation of day-to-day operations during and after the deal.

1. Accurate Business Valuation

The main reason working capital management is significant during M&A is its effect on the business valuation of the target company. Companies that manage working capital effectively tend to have better liquidity, which decreases financial risk and can enhance the overall valuation of a company. 

A company with poor working capital management may be concealing liabilities or cash flow issues, which could weigh negatively upon its valuation. In fact, according to Deloitte, companies that manage their working capital can increase their valuations by as much as 20% as a result of M&A deals.

2. Continuity After the Merger

Ensuring business continuity after a merger or acquisition is perhaps one of the most complex elements of the integration process. Inefficient working capital cycles of the two companies may cause disturbances, such as delayed payment and material shortages. 

Any operational problems can easily disrupt the success of the merger. Efficient working capital management would bypass this risk, ensuring that both companies can operate without any form of disturbance after the transaction. Without this, the integration process might face liquidity problems, which may adversely impact ongoing business activities.

3. Maintaining Sufficient Liquidity

M&A deals typically entail substantial upfront capital requirements, and maintaining sufficient liquidity at this time is important to successfully close the deal. Companies with ineffective management of working capital might not be able to satisfy operating costs as well as short-term liabilities in the aftermath of the deal. 

The buyer should assess how much working capital the target company requires in order to ensure that there are ample funds for day-to-day running and that it is not going to experience financial shocks. A lack of liquidity can stall the integration and even lead to the company not being able to reach its complete potential.

For instance, if the target company has sizable accounts receivable but lacks cash reserves, the buyer would have to inject additional cash to ensure smooth operations post-deal.

In this case, the buyer would have to make up a working capital deficiency of $1 million to ensure liquidity after the acquisition.

4. Synergies and Integration Expense Management

One of the key objectives of M&A deals is synergies, including cost savings or efficiency enhancements in operations. Efficient working capital management makes it possible for integration to occur easier and faster, as the benefits of the combination of the two firms are realized early. 

Working capital management ensures adequate liquidity to both companies, hence ensuring continuous operations and allowing the realization of these benefits faster. A disorganized handling of working capital may delay integration efforts. Hence, the company fails to realize the expected synergy as planned.

5. Investor Confidence

It is also important to ensure investor confidence by managing the working capital appropriately. Showing good working capital management during the M&A process will reduce investors' fears about the continuation of business operations effectively and will fulfill post-transaction obligations. 

Conversely, a mismanaged working capital management situation raises the investor's fear level about liquidity issues, challenges in running business operations, and the risk involved. Effective management of working capital ensures business continuity and also lends an air of credibility to the merged or acquired company, thereby building trust with investors, which helps in further growth.

How Can Virtual CFO Services Help with Working Capital Management in M&A?

Given the complexity of managing working capital during M&A transactions, virtual CFO services provide valuable support to acquirers and target companies. Here is how virtual CFO services can help effectively manage working capital during the M&A process:

1. Skilled Negotiation Support

The virtual CFO gives strategic negotiation support, ensuring that there is mutual understanding and agreement between the two parties regarding the working capital adjustments. In a typical M&A negotiation, it is common for the buyer and target company to agree on a "working capital target," that is, the working capital needed to keep the business running smoothly following the transaction.

A virtual CFO would thus guide the two parties through this procedure and could make sure that the deal was fair on all sides. This will prevent disputes and optimize the financial terms of the deal.

2. Accurate Valuation and Due Diligence

Virtual CFO services also assist in ensuring proper and accurate valuations in the M&A process. Among other things, reviewing working capital is a vital part of the due diligence process in assessing the financial health of the target company. An especially important aspect of maintaining the right level of working capital in valuation, an astute virtual CFO avoids later surprises. Virtual CFO services also help prepare all necessary financial documents and provide potential investors or buyers with organized and transparent financial data.

3. M&A Data Room Facilitation

Due diligence is part of a very critical stage of M&A, and much of the process involves reviewing the target company's financial documents, including its working capital position. A virtual CFO helps set up and manage a well-organized M&A data room secure repository where all necessary financial information is shared with potential buyers or investors.

Virtual CFOs ensure that all data related to working capital management is included and provide expert support in the due diligence process in order to ensure that there are no gaps in the financial data.

4. Effective Due Diligence Management

Due diligence is often a very cumbersome process that includes stakeholders such as accountants, auditors, and internal teams. Virtual CFO services help streamline the process by gathering and presenting critical financial data like working capital trends and liquidity analysis in a structured and understandable way. This tends to make the review process easy and ensures that the M&A transaction isn't delayed or confused unnecessarily.

5. Identifying Operations Efficiencies and Integration Planning

After the M&A deal is concluded, efficient integration of the operations of both businesses is key to realizing synergies. Virtual CFOs serve to identify working capital improvement opportunities in both companies and provide strategies for improving cash flow and optimizing inventory management. This ensures a smooth post-deal transition, eventually facilitating the realization of financial goals for the combined entity.

Conclusion

Working capital management in M&A transactions is more about the financial health and operational continuity of the combined entity rather than just liquidity management. Virtual CFO services are critical expertise when most needed, from due diligence and negotiation to integration and post-deal optimization.

For seeking special experts offering the best virtual CFO services for M&A transactions, CFO Bridge is the ideal choice to go for. Our experienced team ensures efficient management of working capital to let the M&A deal go on with a smooth flow and deliver the expected value. Contact CFO Bridge today to know more about how our virtual CFO solutions can support your business in M&A success.