Trapped Cash – or not? Buyer vs Seller perspectives
October 03, 2016
One of the common issues relating to adjustments between Enterprise Value and Equity Value is trapped cash or cash in the nature of working capital.
What is trapped cash?
Trapped Cash denotes the difference between the book value of any cash and the realisable value that a Buyer will be able to freely access and use to pay down debt at Completion. Whilst in principle the target business’ cash will be added to the Enterprise Value to calculate the final purchase price, the Buyer will expect this adjustment to be net of any Trapped Cash, therefore the identification and measurement of Trapped Cash is likely to be a point of contention between the Buyer and Seller.
Some points for consideration include:
Cash trapped due to structural restrictions
A Buyer will typically regard cash that is held overseas and which cannot be repatriated as Trapped Cash. A Buyer may also argue that dividend blocks in cash generating subsidiaries may result in cash not being freely available to the parent company for the pay-down of debt. In such cases, a Buyer may argue to pay for the realisable value of the cash (e.g. after the deduction of any withholding tax charges on repatriated amounts) rather than the book value.
Conversely, a Seller may look to receive full value for any apparently Trapped Cash by arguing that the cash is freely available to spend in the country it is located in, to invest in capex or working capital or pay down local debt. A Seller may also argue that cash can be made freely available by other means, such as by loaning the cash to the parent company rather than paying a dividend.
Included within the reported cash of the business may be amounts that the company is required - either legally or contractually - to provide as security to a third party, such as import duty deposits with HMRC or cash-backed guarantees. A Buyer will typically argue that this is Trapped Cash and will attribute nil value to it.
Whilst this argument is often accepted by Sellers, they may still be able to gain value from the deposit. If the cash security has earned interest whilst on deposit and if this interest income is credited below EBITDA, the interest has not been reflected in the Enterprise Value of the business (or the net debt adjustment). The Seller can reasonably argue that the interest income should be added to the EBITDA of the business and included in the EV at the applied multiple.
Cash in the nature of working capital.
Buyers can sometimes argue that Target companies hold significant amounts of cash which is required for the business to operate and to generate the EBITDA from which Enterprise Value has been derived. An example is the retail and leisure sectors where businesses require a level of cash in tills for them to be able to service their customers.
Sellers may seek to include these balances within cash in order to receive full value for them in the purchase price. Buyers typically argue that this is Trapped Cash, but rather than attributing nil value to it a Buyer will likely propose that such amounts are a part of the business’ operating working capital. If accepted, the Buyer’s position will only adjust for cash in tills or in transit at completion against a ‘normal’ level as part of the working capital mechanism.
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 Trapped Cash 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.