In the world of mergers and acquisitions (M&A), understanding the concept of trapped cash is crucial. This hidden item on the balance sheet can have a significant impact on the valuation of a company and thus on the final purchase price.
Yet in practice, trapped cash is often discovered late in the process - with all the consequences that entails.
What is trapped cash?
Trapped cash refers to cash that is not freely available for distribution to shareholders or use within the company due to regulations, tax considerations or operational constraints. On paper it may appear that there is plenty of cash, but in reality some of it is locked up.
Practical examples
- Regulatory restrictions: In some countries, currency controls prevent profits from being repatriated to the parent company. This can result in significant amounts being "stuck" in foreign entities.
- Tax considerations: Tax laws can complicate the repatriation of overseas profits. Consider, for example, unrealized gains that would be directly taxed upon distribution. Tax-blocked accounts, such as a G account, can also limit the free availability of cash. A G account is a blocked bank account that may only be used for the payment of payroll taxes and/or VAT, and is commonly used in the case of chain liability in, for example, the construction or staffing industry. For buyers, it is important to realize that the balance in a G account is functionally limited in its use.
- Operational liabilities: Amounts collateralized by bank guarantees or future obligations, while liquid, are functionally unavailable.
Why is trapped cash relevant in acquisitions?
When a buyer values a company on a cash-and-debt-free principle, it is often implicitly assumed that all cash is available. If trapped cash is overlooked in this process, the risk arises that the buyer will overpay.
Therefore, it is important to identify trapped cash in a timely manner so that the value of the business is determined on a realistic basis.
Strategies to address trapped cash
- Thorough due diligence: analyze the balance sheet and underlying documentation to determine what portion of cash is actually freely available.
- Price negotiation: Use trapped cash as a negotiating point. Buyers can adjust the purchase price accordingly or include guarantees in the purchase agreement.
- Structural solutions: In some cases, creative structures are possible to improve the availability of cash, for example by refinancing or modifying the legal entity structure
- Tip for buyers: During your due diligence, ask explicitly about the availability of cash. Not everything on the balance sheet is readily available.
Avoid surprises at closing
Trapped cash is an underestimated phenomenon that can have substantial impact on the outcome of a transaction. In practice, the issue often only comes up in the final stages of negotiations.
Addressing it early in the process can prevent surprises and create a fairer playing field in pricing. A deliberate approach to trapped cash contributes to a transparent and manageable acquisition process.
