My name's Jonathan.

We're gonna spend the next 60 minutes talking about M&A completion mechanisms.

Okay? So we have just under an hour to work through completion mechanisms.

If you open up the file, we're gonna grab a look at the workout sheet, see if you want to move a couple of sheets to the right, to the workout sheet, that would be great.

I'm gonna do the same, hold down, control and tap page down, or if you prefer, just use your mouse.

Okay? So let's just do a quick sort of overview of what we're intending to talk about here.

And if you've just joined, I can see we've got more people joining.

So if you've just joined, welcome along.

If you jump onto the chat box, I've just posted on the chat box a link to the materials, which you may already have.

Okay, so let's do a bit of an overview.

I'm interested in acquiring a company and maybe that company is you, so I could be the buyer and you guys are the target, and we will likely negotiate on the price.

And I'm, I'm sure you're familiar, you know, with how that works.

We could take your share price and we could apply a premium to your share price, which might be like 25% or something.

Or alternatively, we could look at your enterprise value.

So with your enterprise value, we could apply multiple from a comparable business and pick up your EBIT dull or we could build a DCF, we could build a discounted cash flow.

And if you think about how a discounted cash flow would work, we'd forecast out your revenue and we turn that into net operating profit after tax.

And if we wanted to move to unlevered free cash flow, we'd need to think about the, the change in your operating working capital and the CapEx and the, and the, and the depreciation for your business.

So they'd be important line items to come down to unlevered free cash flow and ultimately arrive at enterprise value.

So either we're using a DCF or a multiple to value your ev or we're using a premium to value your share price and then arrive at the equity purchase price.

So by one way or another, we're gonna agree, we're gonna agree on a price today, okay? Now, if we agree that this is gonna move forward and I'm gonna buy your business for a certain price, the issue here is that to get from that initial point in time to the completion of the deal might take a few months.

And in that intervening period of time, some things might happen for your business.

So, and there are a few things we could talk about here.

For example, in that period of time, you might borrow more money, you might take on more debt, and that's probably okay, because if you think about it, if you guys borrow money, then you should have cash available.

So, you know, debt would go up, but cash would go up, or you might use that cash to go and invest in more pp and e or more, more maybe inventory.

So if you have more debt, it's not necessarily a big issue as long as there's an asset sitting alongside that, that matches off against that debt.

But one of the things I might be concerned about is what if you borrow some money and you take the cash that you receive and you pay yourself a dividend, then we've got cash leaking out the business.

And that would be an issue, you know, between us agreeing the deal and completing the deal.

If the business ends up with more debt, but no other assets to show for it, then actually I feel like I'm overpaying for the business.

Equally, you might be in a situation where your business generates losses.

So in that period of time, despite being reasonably successful, historically, you generate some unforeseen losses.

And as a consequence, that might eat into the cash balance.

So we've got a situation maybe where you borrow money and you extract cash from the business, or perhaps the business generates some unforeseen losses, and they're just a couple of examples.

But the issue would be that we've agreed a price, there will necessarily be a period of time before the deal closes and on close you hand over the business to me, in a condition which is not as I expect, okay? A worse condition than I expect.

So the question is, well, how are we gonna deal with that? And that's really what these materials seek to address.

So if we have a look at workout one, it says A acquires B. So why don't I, B, A and you guys can be B, so I'm the buyer and you can be the target.

So A, that's me bids a thousand for all the shares of B and the shareholders accept.

And so the equity purchase price, the amount I'm paying for your equity is 1,000.

That's not in dispute, that's factual. They've given us that information.

It says complete the transaction in the scenario below.

So the available financial data ad announcement.

So how is this gonna work? In order to make that bid of a thousand, I would need to rely on some historic accounts.

So presumably you guys have published a 10 K or a 10 Q or you've got some sort of annual or interim report I can make reference to.

So my initial bid is based on that.

And then once we are, in agreement, then what I'll ask you to do is open up your books to me so I can do some due diligence and we'll go through that due diligence process.

And I might make some small adjustments to the price, okay? But, but really the information is based on those historic accounts and also me taking a closer look at your general ledger, at your, you know, at your numbers within your business and and maybe making some adjustments to that, that those historic accounts to arrive at a, at an equity purchase price.

And I've done that, okay? And we've agreed on a thousand.

Now, out of interest, what does that represent in terms of maybe the enterprise value? So how am I valuing the underlying operating business if I'm bidding a thousand for the equity? Well, these numbers are really easy.

At the date of the announcement, you've got debt of 200 and you've got cash of 100.

And for the time being, I'll just ignore the information below. We'll come back to that in a minute. And so if we scroll down, perhaps I'll just zoom out a little bit.

If we scroll down, the question is, what is the original equity value that I'm bidding? And that's a thousand from above.

That's just some formulas in there.

So the, and we're gonna do this in bold, so gotta do that in bold even.

So the original equity value is equal to a thousand, and that comes from here, Okay? And at the point I made that offer, it occurred to me that you had debt of 200, you had cash of 100.

And so the enterprise value equity of 1,000 plus the debt minus the cash, the underlying EV would've been 1,100.

That was how I valued you.

And then we could take that number and we could divide that by your EBITDA to figure out what multiple, I think I'm acquiring you on now at closing.

And now I'm gonna write reference to some of the data further down.

So we, we've agreed on that and I'm paying you a thousand job done. Let's keep it really simple. That's what I'm paying, okay? Now, at closing, your debt happens to not be 200, but has gone up to 300.

And I'm thinking that's fine.

Like, I'm kind of relaxed about you having more debt when I, when we close the deal.

But the only proviso there is that you would need to also have a corresponding increase in cash or other operating assets, maybe if you've spent that money.

So if you have borrowed more, like I understand that because your business is growing as you know, as you're handing it over to me, so you've borrowed more money, that's cool, but I'd need to see an asset corresponding to that.

So you've got extra debt.

So it's kind of a concern because the closing cash is 100, and when I made the announcement, your cash was 100.

So I'm now left scratching my head thinking you've borrowed more money, but there's no cash there.

Well, maybe you've bought more PP&E or maybe you've bought more inventory with it because the business is growing, you're anticipating that growth and you know, perhaps it's getting closer to Christmas and that's why you've done that.

But when we look at your working capital, I think that's taken to me operating, working capital.

An announcement, it was 50 million and it closing the deal, it's 50 million.

So I'm now thinking, look, where's the cash gone? As far as I'm concerned, I'm paying.

And let's just assume I am paying that.

So I'm paying 1,000.

And when I come to take ownership of the business, the enterprise value is 1,100, but you've still got cash of a hundred and you've got a debt of 300, the business is only worth 900.

So if you focus on the two rows I've highlighted in yellow, that's, you know, that's a worry for me, that's a concern because I've paid 1,000 for the business and when I take control of it, it's 900.

Now, I probably wouldn't tolerate that.

And, uh, and I'd be asking questions and perhaps if we've thought about this in advance, what we sh what I should have put in place is some sort of structure to adjust the price post acquisition for any changes that have happened between announcement and closing of the deal.

And, and that kind of thing that's bouncing around in my head is referred to as completion accounts.

So perhaps we, I should have said early on in the process, I'm gonna make you an offer.

We're gonna do some due diligence and we'll figure out, you know, we'll, we'll take a closer look, we'll figure out what I'm gonna pay.

I'm gonna pay you that money done on the day. We agree, done. But then post acquisition, as the buyer, I will prepare because I'm now gonna own the business. So I've got full control of all the data.

I will prepare a set of closing accounts.

And if I find as a consequence of preparing those that you have more debt, you have less cash, or you have less operating working capital, or less PP&E.

So if the numbers have moved against me, then I wanna reserve the right to true up the price.

I wanna adjust the price for post completion events.

And that is what completion accounts are. And perhaps, you know, that might not be what I've put in place here.

And in that instance, I've effectively overpaid the comment says, reduction in reduction in value paid to the vendor.

Well, I'm gonna say that the buyer, which could be me, has overpaid the buyer has overpaid the business, or the target has more debt. That's right, isn't it? It's got more debt.

Yeah, it's got debt of 300.

We don't have 200 but no corresponding increase in assets.

Be those cash or be those operating assets, it doesn't matter.

I'm just gonna post the link to the materials, by the way, on the screen. So I'll just see a couple of people have joined since I've been chatting away.

Okay? So if you follow that link, there's some materials there that I'm working through.

Alright? So I mean, either I'm just very upset because over paid for the business, or we're gonna use completion accounts. And I think as I suggested here, the the value paid to the vendor is gonna be reduced scenario B.

Okay? So these are exactly the same numbers.

It's exactly the same idea. Financial closing data.

Now we've got debt of 200.

If I scoot up originally an announcement, we had debt of 200, and now we've also got debt of 200. So that's the same. I think this situation is very unlikely in the real world, but an announcement, we had cash of 100 and now I've closed the deal, we've got cash of 150.

So you've sold the business to me, you've handed it over with more cash than I had anticipated.

That's like a little bonus to me, and I'm not gonna pay you for it. Well, maybe I'm, if we're doing completion accounts, but if we haven't agreed that, then I'm not gonna, I'm not gonna pay you for it.

And so, I mean, that wouldn't happen, right? You, you would extract that value from the business before you handed it over to me.

But nevertheless, let's, you know, let's just mess around with some numbers so we can just understand really what's going on.

So the original equity value, if I go and grab that from the previous example, it was 1,000 and the original debt value.

So I'm repeating exactly what we've got here is 100 and the original cash value is going to be 100.

And so the enterprise value would be, what would it be? The equity value plus the debt minus the cash.

Let's just color code this in exactly the same way. Okay? So the original equity value is 1,000.

And so I'm, I'm valuing the business at 1,100, the operating business, the EV at 1,100, and then there'd be some multiple, you could calculate off the back of that if we had EBITDA or EBIT or sales or something.

Anyway, at closing, the debt is still 200, that's great.

But the cash, it's a nice little bonus when I buy the business and I go and have a look at the account bank, bank account, I think these guys must be nuts because they've sold the business to me and we'd agreed there'd be a a hundred million in the bank and they've given it to me with 150 million in the bank.

You could see that wouldn't happen, right? You'd extract that.

But let's imagine it did happen just for the sake of having an example to look at the closing equity value, the EVs 1100, and we add the cash and subtract the debt to kind of work back to the equity value.

I've just paid you a thousand for something and when you've handed it over to me, it looks like I've received value of 1,050.

So I'm gonna say the buyer has a great deal, exclamation mark, the buyer has underpaid, there is more cash, but no more debt.

Really, really good. Now, if we're using completion accounts, then you might circle back and say, Jonathan, let me hand it over the business to you because of just the kind of the flow of capital through the business.

The point in time, the exact point in time that we closed the deal, uh, it just happened that there was more cash in the bank account that was being used for something, or I don't know what it was being used for.

And so you'd say, look, you paid an extra 50 million, so can we have that money back? Now I might say, I'd really rather not do that, but you might say, but we have an agreement.

So perhaps if we've agreed to use completion accounts, then I have an obligation to, I'm gonna call it true up these numbers.

Okay? So, now let's look at workout two.

And workout two really thinks about completion accounts in a bit more detail.

So out two says, can you calculate the estimated equity price and the adjusted equity price based on the data given below? Assume cash and debt remain unchanged and the acquisition is closed using completion accounts.

So I'm getting a couple of useful bits of data there.

We're using completion accounts and cash and debt remain unchanged.

So what we, what I mean by that, what the question means by that is that we announce a deal, you know, we agree a price, and at that point, I look at your historic accounts and figure out how much cash and debt you've got, and all the kind of valuation is based on that.

Now, when we come to close the deal, like thumbs up to you guys when you, when you, we close the deal it's got the same cash and the same debt that we had when I originally made the announcement. So I'm actually really happy about that.

Because it seems like you've handed it over in the same condition.

But let's look a little bit deeper.

Apparently your business has normal working capital of 200 million.

But it looks like on completion, you're actually gonna have a hundred million of working capital.

So I'm saying, well let's imagine that's inventory.

I'm saying, well, like your inventory's supposed to be $200 million of inventory, but it looks like you're about to hand it over only 100 million dollars inventory.

So what's going on? Where's the extra inventory? And you could say, oh, we've reduced the inventory to release some cash into the business.

And I might say, that's okay, where's the cash? Because the cash and the debt remain unchanged.

And really answer is you've extracted that from the business.

And then if we look at the CapEx, I could say just looking at, you know, every year the business is growing and you, you're supposed to do some CapEx.

And so the plan CapEx is 300 million, but it, it looks like you're gonna do you're gonna hit 300 million.

It looks like you're gonna hit 350 million of CapEx by the time you complete.

And you might say, oh yeah, Jonathan, we meant to speak to you about that.

For some various reasons.

We've, we've sort of accelerated the CapEx for the business.

And you'd be saying to me, so Jonathan, you'll have to pay that extra money because we've kind of invested more in the business.

And I might say, oh, no, but if you've bought more PP&E then I guess you've probably taken on more debt.

And so all evens off you say, no, no, no, the debt's the same. Perhaps you'd made some extra profits unexpected profits, you generated a bit of extra cash.

But rather than leave that sitting as cash, you've invested that into PP&E.

So it feels like we're gonna need to do some adjustments.

And this is great, but it's also not great.

I mean, there are two sides to every argument.

So we're going to, we're gonna try and explore why completion accounts are fantastic idea and why they frankly can be a bit of a pain in the butt.

So what enterprise value have, we agreed to buy the business on? Well, it says here, the agreed cash free, debt free price.

This is the ev.

So the enterprise value is the, is usually referred to as the cash free, debt free price.

So the cash free debt free price is apparently a thousand.

And if that's the case, initially, we looked, I make reference to your historic accounts, you've got cash of 300, you've got debt of 400.

These are free simple numbers.

The, let's color this in yellow, the estimated equity price ev and that's enterprise value.

So it's an asset plus the cash minus the debt.

So I'm saying, you know, I'm gonna give you $900 million to buy your business.

That's how I value it.

And um, and that's a sort of our, our, our initial discussion on price.

And, and perhaps that's what I pay. Okay? So perhaps I, you know, I pay you 900 million and then subsequent to me buying the business for 900 million and then having access to the accounts, I have a look in detail.

You know, it's exciting, right? Just bought a business.

So you're gonna go and have a look in the warehouse and look at their inventory and you're gonna have a look at the numbers, et cetera.

And when you do that, you think, wow this isn't quite what I expected because the working capital is 100 million dollars worth. That's what I make it to be.

And normally it should be 200 million.

So I feel like immediately having bought the business, I've gotta go out and replenish the inventory.

So I've gotta spend a lot of cash on that.

And really that's not on because that was supposed to be there in the first place because the normal working capital is 200, and it's on that basis that I've bid a thousand for the operational business.

So, but you know, I'm not annoyed about it.

We're just gonna adjust it because we're using completion accounts.

I'm just gonna go back to the seller and say, I think actually, given the condition you handed the business over, I've overpaid for it.

So I wanna refund now for CapEx.

And I honestly, as a buyer would be reluctant to actually want to admit this because what we're gonna say next is gonna increase the price for me.

I don't, you know, I wouldn't want to do that, I'd just maybe ignore this.

But, the CapEx, estimated CapEx on completion of 350, I was, I was expecting it.

The plan was to have 300 million.

And so there's an extra 50 million.

Now that means that, and let's color this in yellow just to follow that color ordination that we used before.

The estimated equity price is 900, that's equity.

And we're gonna go and grab the reduction from the operating, operating working capital adjustment and the increase in the CapEx.

So I'm saying, I guess what I'm saying is I've just paid you 900 and looking at the businesses you've handed over to me, I think I should have really only paid 850.

So I would like to have some money back.

And you might say no, and I'd say Aha.

But I will refer you to our agreement when we initiated the M&A initiated the acquisition.

And in our agreement, we've agreed that we're gonna review the accounts post acquisition, and then we're gonna make a true up payment.

So if I've overpaid, then I'd pay some back to you.

And if I've, yeah, sorry, if I've underpaid, then I'd pay, I I I'd pay some extra to you.

And if I've overpaid i'd, I'd retrieve that from you.

So we've got that. Now, the problem is that this will inevitably lead to quite a significant amount of legal arguing.

And this can really kind of drag on.

So I really like completion accounts because I think, you know, you are at one level you're saying, I'm only paying for what I've, what's been delivered to me.

You know, if I've overpaid, I'm gonna be able to claw that back and vice versa.

So I think it's actually a really good idea.

But the issue is, I think the, what's the big word here? Uncertainty. The issue is uncertainty.

So the problem is that you, I don't really know exactly what I'm gonna be paying until we've dealt with these completion accounts. And this can take a long time to kind of drag on and you don't know what you're gonna be receiving.

And you might say, well, is it a problem? It's a massive problem. Imagine if we're in private equity and you are raising some equity capital and you're raising some debt capital, you don't want to be in a situation really where you have to return capital immediately to investors.

You know, if you do that, investors will say, well, we've invested money in the fund and that's supposed to be generating a return for us, and now you're giving it back to us, so we're gonna go and do something else with it.

That's not a great situation.

Probably even worse would be in a situation where you have to pay more.

And so you'd have to go and secure more funding to do that so that, you know, completion accounts are actually really, really a good idea.

And they mean that I think everything's very fair and equitable, but the issue is uncertainty.

Now let's grab a look at workout three, I think Workout three and Workout four.

Just sort of explore this idea a little bit further.

We have got a, someone that's joined just as I've been chatting away, so I'm just gonna post into the chat box, the link to the materials if you need that.

So let's have a look at Workout three and out four.

Because they kind of go hand in hand.

So Buyer Inc, which I guess could be me, is acquiring Target Inc. Which I think probably should be. You calculate the equity value at the announcement and the closing equity value given the information below.

So there is a, maybe I'm gonna draw this pretty unsuccessfully, I should imagine.

But there is a kind of timeline that we're working to that maybe would look something like this and well maybe just do a, a box in the middle.

I'm just gonna shade in a little bit like that.

Okay? So initially it's kind of here we've got an announcement and that's based on the historic accounts.

So, you know, I want to, you know, I wanna buy the company and I can use the information that's available to me. So I've got some historic accounts.

And then once that's happened in the middle here, we've got some due diligence, okay? So you'd need to, I'd need to sign some sort of non-disclosure agreement so that you can open up your books to me and sunlight heads of terms.

So you can open up your books to me, and then I can do some due diligence and whatever data I'm working for on these historic accounts is still valid, but I might just adjust that a little bit as I uncover things in the due diligence.

And then we get to, that's kind of line here, line in the down here, which is completion.

And that's when we actually pay, right? So completion, I'm actually just physically gonna pay for the business and take ownership.

And then after that completion happens, the kind of the, the, the end of the process here, you've got completion accounts and true up, some kind of true up, oops, okay, some sort of true up.

So there's this timeline. Let's, let's agree a price. We'll announce that, let me have a look at the data.

Let's open up a data room and like do a load of analysis and due diligence. And then let's figure out, hammer out an actual funnel price, which probably, well hopefully won't be too far away from the original announcement price, but we'll accept that we might not capture all the data here, because once we own the business, then we can have a, a more detailed look.

And if we find that the price we paid is not, you know, in line with the value we really see in the business, and that's okay.

Because there'll be some sort of true up.

And that's what's happening here.

So it says, Buyer Inc is acquiring target.

Calculate the equity value announcement and the equity value given the information below, assume the is closed using completion accounts.

Okay, the agreed cash free, debt free price, you know, originally was 300.

Let's just move these over to the right a little bit.

Yeah, let's just get that way.

Okay, so re cash free debt free price was was 300.

The information from the accounts pre-offer, yeah, the historic accounts, this is how much cash you had, this is how much debt you had, and this is what your assumed average working capital requirement would be for the business.

And then information from the completion accounts.

So the due diligence we assume hasn't really done anything, and we just stick with that value.

But it looks like everything's pretty much the same apart from the lack of operating working capital.

So at the announcement, and also I think really here completion when we pay, so there's no mention of any sort of due diligence changes here.

The equity value announcement must be the EV of 300, plus the cash of 50 minus the debt of 100.

So the equity value and announcement is 250.

The equity value at closing, let's maybe put that in yellow just to draw your ither would be still 250.

Like why should that change? And you say, well, but it would change because you might have more cash or less cash or more debt, or le less debt. And I'd say, no, we haven't. Look, we've got, we we thought originally had 50 of cash, we still got 50 of cash.

We thought we had a hundred of debt. We still got a hundred of debt. Okay? But, but plus open bracket, you might have say a different level of working capital.

Well, we shouldn't, but we might have. Okay? And actually the working capital, the working capital, let's grab that, sorry, plus open bracket.

The working capital here is nothing.

Now that's a real worry because I thought I was buying a business with minus the working capital of 100.

And so we are down like 100 million of working capital, and therefore the closing equity value would be not 250, but 150.

Okay? And so I would ask you to pay that.

I would ask you to pay that money back to me.

Okay, all good.

Let's do the same thing then.

So if we look at work out for exactly the same scenario, probably very unlikely, I would say if we look at work out four, because it's the reverse situation where the seller's handed over a business that has more value in it.

So I, I don't think it's very likely you could say, well, it doesn't really matter, does it? Because if you're using completion accounts, it all gets trued up anyway.

Yeah, but you just have to argue about it.

Well let, let's talk about it.

So Buyer Inc is acquiring Target Limited, calculate the equity value at announcement and the closing equity value given the information below, assume the acquisition is closed using completion accounts.

Same cash free, debt free price, which you might call the enterprise value.

Same number up there exactly the same numbers, pre-offer.

And then from completion accounts, from completion accounts we've got, we had 50 and 100 and 0, we've got 50 and 100 and 150.

So they've got more operating working capital than was expected. They've handed over the business sitting on maybe more inventory, okay? So the equity value at the announcement is a number we've seen before. So we're gonna grab the ev, which is an asset. We're gonna add cash, which is also an asset, and subtract debt, which is a liability.

Okay? So we've got 250. So it's the same number.

The equity value at closing yellow to draw your eye to it.

So yeah, even, there we go.

So the equity value at closing would be the 250.

There's probably no reason that's a change except that plus open bracket, we've got working capital of 150.

The cash free, debt free price of 300 was based on us having working capital of a hundred.

And so if you add 150 minus a hundred, so you're adding the extra 50 actually closing the equity value is 300.

Now you could say, yeah, it doesn't really matter, does it? Because the buyer, and I guess that's me.

I would have to pay you the seller, the extra 50 million.

But I don't think you would really want to do that because, it is an argument, right? I mean, you could say, oh, you know, businesses handed over me had worked Capital 150.

I'd say, how do you figure that I value, I've looked at the inventory, I think loads of it should be written off, I don't agree.

And then we have to go to court to figure out if I'm right in my assertion that a lot of that inventory is basically worthless or if I'm just, you know, trying it on.

And if actually the value is 150, which is what perhaps the seller is saying it should be.

So I don't think you as a seller wanna get into that argument.

So it's likely that you'd liquidate some of that operating working capital and just pay yourself, you know, turn it into cash, pay yourself a, a dividend, then you don't have to really get into that discussion, okay? But we are making the point here that the true up could work in either direction.

So let's look at slightly more comprehensive version work out five, calculate the equity value at the signing date.

Letter of intent on the closing date, and any applicable true up.

So that, that kind of goes back to the diagram that I drew.

We've got the signing date, the letter of intent, so I'm intending to buy the business.

Please show me some detail. So we do some due diligence.

We've got the closing date, and then we've got the completion accounts.

So signing date, closing the transaction, and then, uh, truing up from the completion accounts. And that's what's mentioned here, signing date, the closing date for the transaction, and then the true up from the completion accounts. So there really are, if we just grab a 10 here, you know, there really are like 1, 2, 3 sequential stages in the transaction.

Uh, transaction will be completed using completion accounts, the data available at signing the letter of intent.

And here it says historical accounts is as follows.

We've got EBIT dial number and a multiple that we've agreed on.

And from that information we go down, we can calculate the product of 15 six or 6 in 50 is 300.

So the cash free debt free price is 300.

Initially you guys have got debt of a hundred and you've got cash of 50.

And that being the case, let's color code this in yellow.

That being the case, I'll tell you what, I reckon your business is worth 300 million based on your historic EBIT dollar number.

And I'm gonna to the ev add the debt and I'm gonna subra the cash.

So I think 250 is the announcement.

Okay? So's my timeline over here.

Oh, where's it, where's it got over here? Sorry.

An announcement. I'm saying 250. I'm not paying 250.

I'm not doing that. Okay, because now we need to do some due diligence before we close the transaction.

So in our timeline, the letter of intent 250.

Now the due diligence, during the due diligence, the acquirer estimates, the completion accounts to be as follows.

So now I've got a bit more, exposure to your numbers and made able to dig into them a bit.

I don't own the business yet, so I don't own all of the data, but I, you know, I have a lot more access.

I can see that the debt is gonna be 100.

Well, that's good because that was same number as I had in the historic accounts.

And the cash is gonna be 50, but the working capital is going to be 80.

Now, I would want to compare that.

Let's go and grab a different color.

So I would want to compare the 80 of working capital that we see in the due diligence to the target working capital of a hundred.

So that's a bit underwhelming 'cause you haven't got as much working capital as really I think you should have.

And the CapEx. So I'm expecting you to spend between, you know, the historic accounts and when I take ownership of the company, I'm expecting you to spend 50 million on PP&E 50 million on CapEx.

And it, whoops, let me join up to the right numbers here.

And it looks like you are gonna be spending 40 million, so you're a bit down on, so I'm gonna say down on OWC and down on CapEx, not great news.

Okay? So the, from above the, there we go.

From above the cash free, debt free price is, and, you know, always will be as our kind of anchor, 300 million.

The debt that you guys have is a hundred million.

The cash that you have is 50 million, which I see through my due diligence.

Um, and if we scroll down, I reckon you are going to be hitting working capital, operating working capital of 80, and it should be a hundred.

So I reckon I'm gonna bring the price down as a consequence of that.

And the CapEx is gonna be 40 and it should have been 50 to completion.

So I'm gonna bring the price down there as well.

So the equity price at closing, and I'll have this in yellow, would be the ev the cash debt-free price, plus the cash minus the debt.

And then we're gonna pick up the sum of these completion account adjustments.

So it comes 220, this is the equity price closing.

I'm gonna say this is what I actually pay in the first instance.

So this is why I actually pay in the first instance.

So now we're closing the transaction back up to the diagram I sketched out, is, there we go.

I can find it. So, you know, we got the historic accounts, we have a price, an announcement.

We worked towards, they, the target through open its books, and we did a bit of due diligence, and then we adjusted that price a little bit.

And then we've actually paid whatever it is you paid, uh, 220, was it or something? Yeah, it was 220. So that's what we actually paid.

Uh, you'd think the due diligence would do, due diligence would be enough to be certain over the value, but actually I'm only in due diligence.

I'm only working with data that's been given to me, and now I actually own the business.

It's time to have a really good look.

So additional information can be found in the actual completion accounts. This is, so this is post acquisition you had a bit more debt.

That's disappointing, but it's all right because you might have more cash, and in fact, you do, you have you have extra cash as well.

So I think this is, okay, you working capital was 90 and you know the target working capital was 100.

So the fact that it's come at 90 is a little underwhelming, but it's not terrible because we, through the due diligence, we expected the working capital to be 80 and we, um, we priced accordingly, but it wasn't 80, it came in at 90.

So it did come in ahead of where we expected it to be.

And the CapEx is 45.

And you know, if we go back to the original data, we expected the, uh, CapEx to be 50.

And so the fact that you've delivered 45 is a little underwhelming, but it's not as pessimistic or we shouldn't have been as pessimistic as we were because we thought the CapEx was gonna hit 40.

So we're gonna need to do some, we're gonna need to do some adjustments to this.

The first question is, you know, hey Jonathan, do you know what the cash free debt free price is? And I do, because we've looked at that already.

Let's go and grab that. If we say equals and we go up to 148 cash free, debt free prices is 300.

And now lets look at the debt.

So the debt actually figured to be 101, that's not great, but the cash was 52, so pretty good.

The OWC adjustment that we, you know, really should have made the working capital is 90 minus, it's got to the original position 100.

So the working capital is down by 10 million based on the historic accounts, not down by the 80 million that we originally thought.

It's down by 10 million. The CapEx adjustment CapEx from announcement to completion was 45.

But go back to the original data, we expected it to be 50.

Okay? So that's I at C160 minus C131.

So the final equity value that we're gonna have in yellow would be 300, which is ev it's an asset. So we're gonna add the cash and subtract the debt, and then we're gonna add the sum of those adjustments.

So 236. So I think that we should have paid 236, but we paid 220.

So I think this is an unlikely scenario that I would, as a buyer would want to admit to really, and I'd try and engineer this not to be the case, but there is a, a difference in the price that's been paid and the value of the business when it was handed over.

And if we take the 236 minus the 220, the 220 is what I paid.

And the 236 is what I think it's worth. And we got 16.

And who would pay that? Well, if I paid two 20 for something that we think is actually worth 236, then as the buyer, as the acquirer, I would pay the extra amount over in theory, okay? In practice, I tried very hard for that not to be the case.

What if the opposite scenario occurred? So in workout 6 it says, use the information from the workout above, calculate the true up.

Assume the target pays the dividend of 20 just before completion date.

It isn't the opposite scenario.

It's a, my apologies, it's a dividend.

Look, I'm just gonna say it doesn't matter.

And if you think about that, why does it matter if I'm buying you and we're using completion accounts and right before we close the, the deal you pay a dividend for yourself, it doesn't bother me.

And you could say no, but if we're paying, if you are paying a dividend, how do you account for that cash down, retained earnings down.

So if you're paying a dividend, then you've got a reduction in cash.

And I could say I don't care because we're using completion accounts.

So when I buy the business, if it's got 20 million less cash, I just, when we true everything up, you'll just owe me 20 million.

So you can extract the 20 million from the business if you want to and pay yourself a dividend, but you'll just have to pay me the 20 million back.

You are unlikely to do it. You have to pay tax on the dividend anyway.

So okay, let's pull some numbers in.

I'm not gonna actually change any of these numbers originally, that we have originally.

So I'm gonna pick up the original numbers.

We're gonna get the cash free, debt free price.

We're gonna get the final equity value, make that yellow, and then we're gonna calculate the true up.

So all the same numbers, the cash free, debt free price or above is 300.

Just nothing has changed there at all.

The debt is 101, the cash is 52, or is it, we'll review that in a minute.

the OWC adjustment is still minus 10 and the CapEx adjustment is minus 5.

So you could argue, you could argue that you take the ev you add the cash and subtract the debt, and then you add the sum of those adjustments.

So you could argue these are just the same numbers.

I'd say no, there aren't. They aren't, are they? Because what I haven't done, let's going for purple, is it the target pays a dividend just before the completion account date.

Okay, just before that.

So cash down retained earnings down, let's go to our cash balance.

If they paid themselves a dividend of 52, alright, wait, let me see that.

Okay? If they pay a dividend of 20, I'm gonna say minus 20, the cash is gonna go down, the price was 236.

So we thought, oh, you know, I paid 220 and actually the price should have been 236 and said it was extra to pay.

If I processed that dividend, it's 216.

So in terms of the true up, the value of the business is 216 and the final the price I paid, my value is 216.

The price I paid was 220.

So yeah, this is definitely, this is the price I actually paid.

And now in this new scenario, we've got some changes, but we've also noticed we've got a dividend that's being paid.

So I think there's a true up of four to pay.

And who pays that? The seller.

You guys, if you extract a dividend from the business just before you hand it over to me, then it's less valuable.

And, and so I'm just gonna go back to you and say, something's going on here.

It's less valuable. You'd say, oh yeah, we paid yourself a dividend. And I'd say, well, that's fine, but you need to pay me an extra 4 million.

Okay, for the business, they pay it back, pay back 4 million.

Because I should be paying 216 and in the first, in instance, I've paid 220.

Now, the big issue here is that when we're using completion accounts and you've got these, all these true ups, it's protracted.

I mean, the due diligence when we are in the middle of the deal can afford to be maybe, and I'm sure the lawyers wouldn't like me saying this, but the due diligence in the middle of the deal can afford to be less rigorous because if anything's not quite right, we have this kind of true up process.

So the due diligence in the kind of, in the right, in the eye of the storm when we're doing the deal is less rigorous.

But after the acquisition, it's not the end of it. It's not nearly end of it.

Because we're gonna argue over adjustments and true ups.

And so, not only is that, you know, kind of a fairly frustrating process to go through, it creates a lot of funding uncertainty.

You don't know, um, how much funding you're gonna need to raise for the deal, and that's a problem.

So there is an alternative.

And workout seven is the last workout. We've got about 10 minutes left.

So I reckon that's, it's quite a long workout, but I reckon that's about right.

So it says here, workout seven and it tries to deal with that uncertainty.

It says calculate the purchase price, the equity value, and the final payment to the acquirer, the final payment the acquirer has to make, provided the information below the transaction is completed using lockbox.

Now, simply a lockbox mechanism is just a fixed price mechanism.

So all it is is a fixed price.

So I would say the conversation would run something like this.

Look, I'm gonna buy you a business and we've got your historic accounts and I'm gonna use that to make the announcement.

Then I'm gonna do some due diligence and I want you to open up your books to me. You know, I'll sign a letter of intent, you know, a non-disclosure agreement, an NDA with all of that.

I want you to open up your books to me and I'm gonna do some due diligence.

And then we we're gonna adjust the price, but the price fee offer, you know, will be the final price.

And there'll be no true ups or adjustments from there.

And you might say something like, well, what if you might say to me, well, we hand the business over to you if we're using lockbox, what if the business has got more cash in it than we'd originally agreed? And I would say that would be very foolish of you to do that because I won't be paying you any more money for the business.

So it wouldn't really make much sense.

So there, there's not really an incentive to hand over the business in a better condition.

And you might say, well, what if we'd hand the business over and we've got we've done a lot less CapEx, you know, because it's taken, it was a fixed price. We're getting paid no matter what.

And I, you know, a certain price, but you just don't bother doing the CapEx.

And I would say no. I'd say no. Look,we've got a lockbox approach to this.

There'd be extremely punitive legal penalties.

You know, we will pull you through the courts if you do that.

So don't do that, okay? You, you really, with lockbox, you're signing up, you're gonna receive a fixed price and you're gonna hand the business over in a certain condition.

Now, the only final thing that we might talk about is you could say, when we, when we do the announcement and we complete the deal there's a, a period of time between the two, let's say. Yep, yep. And you, and you'd say, so what usually happens with completion accounts is if, uh, between those two, if we do a really good job of running the business and we hand it over in be in a better condition, we get paid more for it.

I'd say, yeah, I suppose that's true. You do.

And then you'd say, so what about lockbox? If we, you know, we're working hard imagine that the deal we think might take three months to complete.

But imagine it takes six months to complete.

You know, as a seller, you are not getting anything for that because the kind of like the economic point of view, you are really transferring the rights and responsibilities of ownership to the buyer at the point that, we do all that kind of due diligence, you know, and we agree on that price.

You know, there's no true ups, there's no adjustments, there's nothing, there's, there's kind of nothing, nothing else happening. It's really an announcement date in fact that you, you know, and follow your due diligence that you, that you agree on that.

So you'd say, well, if it's, if a, if the acquisition process is protracted, you want to get a benefit, I just think about it. And I think we could do that. I can accommodate that.

What I'm gonna do is we're gonna agree a price for the business, and then I'm gonna pay you an accrual.

I'm gonna accrue some compensation for you for running the business in my stead.

And so if we agree a certain price for the business and then, you know, to completion, there's like three months, then I'll pay you some money for running the business on a pre-agreed rate.

And it does create a little bit of un a funding uncertainty, but it's not very material.

And so hopefully that's attractive to you.

So let's just put, we've only got a few minutes left.

Let's put some numbers in.

So it says, on the 1st of February, year two, the target publishes ordered accounts for the fiscal year ending the 31st of December, year one.

So these financial extracts here, let's be clear, these financial extracts are from the 31st of December, year one. That's where these numbers come from.

We've got some EBITDA, cash debt, OWC and CapEx.

And thereafter it says in row 199 on 15th of February, year two, the acquire contacts the target and make an approach to buy.

So I walk up to SA, I wanna buy the company the acquire vendor agree an EV EBITDA valuation of seven times, and the closing deal is set on May the first.

Remember it's seven times that we've agreed the EBITDA number and that EBITDA number has come from the historic accounts. So based on the EBITDA I'm seeing in the historic accounts and a multiple of seven we're going to agree this deal, which is set to close on the 1st of May in that year, during the due diligence process, the accountant discovers the following.

The OWC requirement is 60.

Well it looks like the OWC was 50.

So,it looks like we need to put more into the business more OWC in. So it's kind of an under investment.

We've got a CapEx under investment of five, so that would need to be addressed as well.

And there's a dividend, which is payable on the 15th of March.

Now I'm talking about this deal on the 15th of February.

They haven't paid that dividend yet.

What happens when they pay the dividend, when they pay the dividend, cash goes down and retained earnings goes down.

So I'm gonna do the valuation based on them having cash of 20 million and debt of 200 million.

But if they pay that dividend in March, then the cash is gonna go down maybe to zero and the debt might go up by 10 or some mix of those things happening.

So I could sort of say, well, maybe don't pay it.

And the company might come back and say, we've kind of got to we're sort of legally obliged to pay the dividend now Because we've announced it.

And so, you know, we've got that liability in that obligation, but it's all right then do pay it.

But let's just reduce the price accordingly, because I'm gonna call that as accept, I'm gonna call that acceptable leakage.

So if we go down it's also been agreed that the existing owners will still run the business to completion. So that's you guys. And I know that this process might be drawn out a bit.

I'm gonna pay you 5% of the purchase price.

Pro r to that for running the business.

We've just got a few minutes. Let's throw some numbers in and figure out what it's gonna cost me.

So the EV would be equal to the EBITDA number. We are given above of a hundred.

And we're told further down that they're gonna pay a, oh, I'm gonna pay a seven times multiple. So multiply that by seven there and oh, let me grab the right number, multiply that by seven.

Okay? We've got cash and cash of 20.

There's no suggestion that, that the numbers looks like it's, it's gonna change from those historic accounts.

They've got cash of 20 a get a debt of 200, but the operating working capital requirement is 60 and it looks like it's gonna be 50.

So 50 minus 60 is minus 10.

I think we're gonna reduce the price because the required a OWC is greater than the a OWC we're seeing on the balance sheet.

There's a underinvestment in CapEx that's gonna come down as well.

And we, we call this permitted leakage.

We've got a, a dividend that's gonna be paid out that hasn't yet been paid out, but it's unavoidable of 30.

So the purchase price would be equal to the enterprise value plus the cash minus the debt.

And then we're gonna say plus the sum of these adjustments.

So I think 475 is what I'm thinking.

I'm paying you now, I have to say we're using lockbox, so we're not gonna negotiate this again, okay? And, and that puts quite a burden on the due diligence happening before the deal, you know, has closed.

So it puts a greater burden.

Because we, we're not, there's no recourse, we're not gonna go back.

We don't quite know when it's gonna close.

So what I'm also gonna do to compensate you for your awesome work running the business is I'm gonna pay you 5% multiplied by the purchase price.

And the point is that this is per annum, so I wanna pro rata that.

But going back to the numbers, all of these calculations, the amount I'm paying for the business are based on the accounts on the 31st of December, year one.

We're not closing the deal on the 31st of December.

We're gonna go through all of January, all of February, all of March and all of April, and we're closing the deal on the 1st of May, that's four months in, so I'm gonna pay you 5% and I'm gonna multiply that by four months out of 12, and then multiply that by the purchase price.

So I'm gonna pay you an accrual for running the business of 7.9 million.

And the good thing about that is if this deal just takes longer or longer and drags on, you might say, forget it.

The world's moved on, the business has changed in value.

And you might say, I'm not getting compensated.

I can come back and say, you are getting compensated for it.

You might say, but we're not using completion accounts, we're using lockbox.

It's a fixed price. I can say it is a fixed price, but on a time basis, I'm accruing some interest for the work you're putting into keeping the business in a good condition and handing it over to me.

So you will, you will get the benefit of that.

Okay, so let's just, we've got a, a minute or so left, so let's just do a quick summary.

The quick summary is that when a company gets acquired, there is a time difference between announcing the deal and closing the deal and stuff happens between those two goalposts. Cash might increase, debt might in cash, might increase or decrease, debt might change.

Operating working capital numbers might change.

We've got to try and accommodate those changes.

And there are two basic approaches and the first one is using completion accounts, crewing up the numbers, quite a nice way of doing it but creates a bit of uncertainty on the, the price we're paying.

And the second approach is lockbox, which is a fixed price.

It's also a very effective approach.

It does place a much bigger burden on due diligence before the deal closes and potentially slows things down a little bit.

Anecdotally, my experience and certainly, in discussions with a lot of people I train, you know, in the big investment banks is lockbox is now predominantly most popular approach, but it's not the only approach to doing this.

Okay guys, we have hit bang on three o'clock, which I know is the end of the session.

I'm sure you'd be very keen to kind of go and get on with whatever stuff you, you need to get on with.

So all that remains for me to say is thanks so much for taking the time to dial into the session.