In the UK corporate landscape, divestments—whether through carve-outs, spin-offs, or asset sales—are strategic decisions that can significantly influence a business’s trajectory. While often driven by goals of refocusing core operations, unlocking shareholder value, or complying with regulatory requirements, divestments are far from straightforward. One of the most critical, yet often underestimated, aspects of the process is working capital.

divestiture consultingIn any divestiture, defining and agreeing on the appropriate level of working capital is essential. This not only affects the final purchase price but also shapes the buyer’s perception of the quality and sustainability of the divested business. For UK-based organisations, particularly in volatile markets and under ever-evolving tax and regulatory frameworks, accurate working capital planning is imperative. Engaging expert services early in the process can help to mitigate risks, ensure fair valuation, and facilitate smoother post-transaction integration or separation.

The importance of working capital considerations in UK divestments, detailing best practices, common challenges, and how to prepare effectively for a transaction.

Understanding Working Capital in Divestments

Working capital is typically defined as current assets minus current liabilities. In practice, this includes inventory, trade receivables, trade payables, and other operational balance sheet items. Within a divestment, working capital becomes a point of negotiation because it directly influences the cash-free, debt-free (CFDF) value of the business.

Buyers expect a divested business to come with a “normalised” level of working capital that supports ongoing operations. If actual working capital at closing is above this normalised level, the seller may receive a purchase price adjustment in their favour, and vice versa. The process of calculating, agreeing on, and settling these amounts is known as the working capital adjustment mechanism, often detailed in the sale and purchase agreement (SPA).

Why Working Capital Matters in UK Divestitures

In the UK, companies undertaking a divestiture must carefully assess how much working capital should transfer with the business. If too little is allocated, the buyer may struggle to run operations effectively post-close, potentially leading to disputes, reputational risk, or price renegotiation. Conversely, transferring excess working capital can result in a suboptimal deal for the seller.

Several factors contribute to this complexity:

Seasonality of the Business: Businesses such as retail or agriculture may have large fluctuations in working capital depending on the time of year. Ensuring these seasonality effects are captured in the working capital target is crucial.
Carve-Out Challenges: In partial divestments or carve-outs, separating intercompany balances and determining standalone working capital is complex. Buyers will expect to see a clear view of the standalone business’s cash needs.
Tax and Regulatory Considerations: UK tax regulations may impact how certain balance sheet items are treated in the transaction. Understanding VAT treatment, customs duties, and payroll obligations is essential.
Industry Norms: Different sectors operate with distinct working capital cycles. For instance, manufacturing businesses may hold significant raw material inventory, while service providers may operate on minimal working capital.

divestiture consultingBy leveraging the expertise of professionals in , UK firms can navigate these challenges with confidence and ensure that working capital is treated in a way that reflects the commercial realities of the business.

Establishing the Working Capital Target

The working capital target, also known as the working capital peg or benchmark, is a key component of the SPA. It is typically calculated based on a trailing 12-month average of relevant working capital metrics. However, a simple average may not reflect seasonality, recent trends, or structural changes.

Key steps in establishing a working capital target include:

Defining Included Items: Determining which line items should be included in the working capital calculation is critical. This often requires negotiation between parties, especially in complex group structures.
Adjusting for Anomalies: One-off items, such as discontinued operations, stock obsolescence, or delayed customer payments, should be excluded or normalised.
Considering Pro Forma Impacts: In carve-out situations, pro forma financial statements may be needed to estimate what working capital would have been if the business had operated as a standalone entity.
Validating Historical Trends: Ensuring the historical data is reliable and reflects the operational realities of the business is key. Discrepancies can lead to disputes or post-close adjustments.

divestiture consultingA good partner will guide sellers through this process, often working hand-in-hand with financial, legal, and tax advisors to establish a defendable and balanced target.

Working Capital Adjustment Mechanism

Once the working capital target is established, the SPA outlines the mechanism for adjusting the final purchase price based on actual working capital at closing.

This mechanism typically includes:

Estimated Working Capital: Sellers provide an estimate before closing, which forms the basis for any provisional price adjustments.
Closing Accounts: Post-closing, the buyer prepares a final calculation of working capital, which is then subject to review and potential challenge by the seller.
Dispute Resolution: SPAs often include provisions for arbitration or third-party resolution in case of disagreements.

divestiture consultingDisputes over working capital adjustments are common and can be costly. Clear definitions, consistent methodologies, and early planning can reduce this risk. Again, this is where expert can offer tremendous value by aligning stakeholders early in the process.

Managing Operational Impacts

Beyond the technical aspects, managing the operational impacts of working capital in a divestment is equally important. Sellers must avoid artificially inflating working capital prior to closing, such as by delaying supplier payments or accelerating collections, which can lead to disputes or reputational damage.

Moreover, the transitional phase—particularly where transitional service agreements (TSAs) are in place—must be carefully planned. These agreements often impact how working capital is managed post-close, especially if back-office functions like finance or procurement remain with the seller temporarily.

Buyers will scrutinise whether the working capital they inherit aligns with the ongoing needs of the business. If there’s a misalignment, it can result in immediate funding gaps or performance deterioration.

Case Study: Mid-Market Manufacturing Business in the UK

Consider a mid-market UK manufacturer divesting one of its product divisions. The division has traditionally shared supply chain, finance, and IT functions with the group.

During the transaction, it became evident that the division had significant intercompany receivables and payables, along with seasonally high inventory levels in Q4. A basic trailing 12-month average would not reflect these nuances, risking an overstatement of the working capital target.

divestiture consultingBy engaging a specialist in , the company was able to:

Conduct a standalone assessment of the division’s working capital needs.
Remove intercompany items and adjust for forecasted seasonal spikes.
Negotiate a balanced working capital target that satisfied both parties.
Avoid post-close disputes by aligning the closing mechanics with TSA arrangements.

The divestment closed successfully, with no material adjustments post-close and a strong buyer relationship maintained.

Conclusion

Working capital considerations are a pivotal part of any UK divestment strategy. Whether divesting a standalone entity or carving out a business unit, sellers must ensure they provide sufficient, appropriately calculated working capital to support the business post-transaction—without compromising deal value.

divestiture consultingEarly planning, a detailed understanding of business dynamics, and alignment between buyer and seller are key to avoiding disputes and maximising value. With the right approach and the support of skilled advisors, UK businesses can navigate these challenges and execute successful, clean divestments.

You May Like:

Working Capital Considerations for UK Divestments

Engaging expert divestiture consulting services early in the process can help to mitigate risks, ensure fair valuation, and facilitate smoother post-transaction