Inter-Company Balances and the Money Go Round

In transactions with completion mechanisms, the cash flows required to settle Inter-Company balances at the completion date can cause confusion. The SPA will often include separate provisions requiring the repayment of any Inter-Company funding balances and Inter-Company trading balances.

Inter-Company funding balances

In a typical completion mechanism, Inter-Company funding balances owed by the Target Company to the Seller Group are treated as a debt deduction in the same way as bank debt.

One possible approach to the settlement of Inter-Company funding balances, is to require the Target Company to repay all Inter-Company funding balances immediately prior to completion. However, this may not be practical. For example, the target may not have any funds to make this repayment.

The Money Go Round

A commonly adopted solution is called a “Money Go Round”. This does not change the price paid for the business but does require additional cash flows to occur at completion.

For example, assume the acquisition of a Target with an enterprise value of £100 and an Inter-Company funding liability of £20. Ignoring any other debt, the cash flows usually occur as follows:

  • At the completion date the Buyer pays the Seller £80, being the Enterprise Value of £100 less an estimate of the amount of the Inter-Company funding balance owed by the Target to the Seller of £20;
  • At the completion date the Buyer puts the Target Company in funds and the Target Company repays the Seller the estimated Inter-Company funding balance of £20. At this stage the Buyer has paid a total of £100 and has acquired a business with no debt;
  • After the completion date, completion accounts are drawn-up showing that the actual Inter-Company funding balance due from the Target Company to the Seller at completion was £22, rather than the estimate of £20. As a result, two adjustments are made to the cash flows:
    • the Seller repays £2 to the Buyer, on the basis that the price deduction of £20 at the completion date for the estimated Inter-Company debt was too small (making the amount paid directly by the Buyer to the Seller £78);                           
    • the Buyer puts the Target company in funds to repay the additional £2 owed to the Seller (making the amount paid indirectly by the Buyer to the Seller through the Target Company £22).

Overall, there has been no change to the amount paid by the Buyer which remains at the Enterprise Value of £100. The key is to ensure that the mechanism works to clear down the debt and adjust the price as above, and that the amounts repaid are acknowledged as being in full and final settlement of the Inter-Company funding liability.

What’s the alternative?

There are other potential approaches which could be adopted to deal with Inter-Company funding balances. One alternative would be the Buyer purchasing from the Seller (on a £ for £ basis) the rights to receive the amounts owed by the Target company in respect of Inter-Company funding balances at completion. The various approaches are likely to have differing taxation implications for the various parties involved and this should be considered when determining the best possible approach.

Inter-Company Trading balances

Inter-Company Trading balances arising in the ordinary course of business between the Target Company and the Seller Group are usually treated as part of the Working Capital adjustment in the SPA in the same way as third party trade debtors or trade creditors. In other words, a “normal” level of Inter-Company trading is factored into the reference level of working capital in the SPA. The actual level of working capital at the completion date, including Inter-Company trading balances is compared to this reference level and an adjustment made to the purchase price. Typically the Inter-Company Trading balances are settled post-Completion in accordance with the existing terms.

For due diligence purposes, the key is to ensure that all Inter-Company Funding balances have been identified as part of the debt deduction and that the Inter-Company trading balances have been included within the assessment of the normal level of working capital.

Find out more about this and other issues that arise during the sale & purchase agreement (SPA) process at our forthcoming seminar on Thursday 6th October at 8:30am in London. Full details and registration can be found here.

What issues have arisen for you around settlement of inter group balances at completion on deals you’ve done? How did you get around them and what was the outcome? Share your thoughts below or schedule a meeting to discuss your situation in confidence.

Nick Williams | Sales & purchase agreement specialist
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