Module IV· Sources & UsesIntermediate
Question
A sponsor decides to use $30m of cash on the target's balance sheet as a source. What are the implications for working capital and debt capacity?
Answer
Mechanics
'Cash on the balance sheet' can be used as a source, but two mechanics must be respected:
- Trapped cash — not all cash is immediately available. Cash in foreign subsidiaries (e.g. a China joint venture) can be blocked by capital controls. In the middle market, often 20–30% of balance-sheet cash should be classified as trapped.
- Operating cash need — the target needs minimum cash for day-to-day operations (typically 1–2% of revenue). With seasonality (e.g. consumer goods, construction) considerably more.
Deep diveShow more details
Example
$30m cash on the balance sheet. Of that, $8m trapped (China subsidiary), $10m operating need. Available as a source: 30 − 8 − 10 = $12m.
Consequence
Aggressive cash use effectively increases leverage — if working capital has to be topped up after closing, it is funded from operating cash flow, which delays debt paydown.
Pitch tip
Seniors often test 'What happens if the sponsor takes $30m but the target can only spare $12m?' — answer: the first working-capital peak can't be covered, so the sponsor has to inject more equity or draw the RCF. Therefore: assume conservative cash availability.