The Working Capital Peg: The Most Misunderstood Part of Any Deal

Ask a business owner what their biggest concern is when selling, and they'll say purchase price. Ask an M&A attorney, and they'll say working capital. The working capital adjustment is the single most common source of post-closing disputes — and most sellers don't fully understand it until it's too late.

What Is the Working Capital Peg?

When you sell your business, the buyer expects to receive a company with a "normal" level of net working capital (NWC) — the short-term assets (cash, receivables, inventory, prepaids) minus short-term liabilities (payables, accrued expenses, deferred revenue) needed to operate the business day-to-day.

The working capital peg (or target) is the agreed-upon amount of NWC that the buyer expects at closing. If actual NWC at closing is higher than the peg, the seller receives additional proceeds. If it's lower, the purchase price is reduced dollar-for-dollar.

Simple Example

• Working capital peg: $500,000
• Actual NWC at closing: $450,000
• Result: Purchase price reduced by $50,000

Or:

• Working capital peg: $500,000
• Actual NWC at closing: $575,000
• Result: Seller receives an additional $75,000

The adjustment is typically calculated within 60-90 days after closing, based on a closing balance sheet prepared by the buyer.

Why This Matters More Than You Think

On a $5M deal, the working capital adjustment can easily swing $200K–$500K in either direction. That's real money — and it comes out of (or adds to) the seller's proceeds after the headline purchase price is already agreed.

The challenge is that working capital is inherently variable. It fluctuates with seasonality, billing timing, inventory levels, and dozens of other factors. Defining "normal" is where the negotiation happens — and where sellers frequently get surprised.

How the Peg Is Calculated

The most common methodology is a trailing 12-month average of net working capital, adjusted for anomalies. But every component of that calculation can be debated:

What's Included

A standard NWC definition includes:

• Current assets: Accounts receivable, inventory, prepaid expenses, work-in-progress
• Current liabilities: Accounts payable, accrued expenses, deferred revenue, customer deposits, accrued payroll

What's Typically Excluded

• Cash and cash equivalents (usually excluded from the NWC definition; cash above a minimum is distributed to the seller pre-close)
• Current portion of long-term debt (treated as a debt-like item, not working capital)
• Income tax payable (seller's responsibility for pre-close periods)
• Related-party balances (eliminated at close)

The specific inclusions and exclusions should be negotiated and explicitly defined in the purchase agreement. Ambiguity here is the enemy.

Common Seller Mistakes

Not Understanding the Definition

Many sellers sign LOIs without fully understanding how working capital will be defined. They focus on the purchase price and treat working capital as a technical detail. By the time the definitive agreement is being negotiated, the buyer's preferred definition may already be baked in.

Fix: Negotiate the working capital definition at the LOI stage, or at minimum, agree on the methodology for calculating the peg.

Gaming Working Capital Before Close

Some sellers try to inflate working capital before closing — aggressively collecting receivables, delaying vendor payments, or building up inventory. Sophisticated buyers see through this immediately, and it damages trust during the transition.

Fix: Run the business normally. The peg should be based on normal operations, and anomalies will be adjusted out.

Ignoring Seasonality

If your business is seasonal, a simple 12-month average may not represent "normal" working capital at the time of closing. A business that closes in December might have very different NWC than its annual average suggests.

Fix: If your business is seasonal, argue for a peg based on the same period in prior years, or negotiate a seasonally adjusted peg.

Not Accounting for One-Time Items

Large receivables, unusual prepaid expenses, or temporary inventory builds can distort the historical average.

Fix: Normalize the calculation by removing clearly one-time or non-recurring items from both the historical average and the closing calculation.

Accepting the Buyer's Calculation Without Review

After closing, the buyer prepares the closing balance sheet and calculates the adjustment. Many sellers accept this without independent review.

Fix: Your CPA should independently review the buyer's closing balance sheet calculation. The purchase agreement should include a dispute resolution mechanism (typically independent accountant review) if you disagree.

Negotiation Strategies

Define NWC Components Early

Don't leave the definition vague. Attach a sample NWC calculation to the LOI or purchase agreement that lists every line item included and excluded. This prevents surprises.

Use a Range Instead of a Point Estimate

Some deals use a collar — a range around the peg (e.g., +/- $50K) within which no adjustment is made. This accounts for normal fluctuation and avoids disputes over minor variances.

Lock the Methodology

Agree not just on the target amount, but on the accounting policies and methodology used to calculate NWC. The same business can have meaningfully different NWC depending on how revenue is recognized, how inventory is valued, or how accruals are estimated.

Negotiate the Dispute Resolution Process

The purchase agreement should specify:

• How the closing balance sheet is prepared and by whom
• The seller's review period (typically 30-60 days)
• The process for raising objections
• How disputes are resolved (usually an independent accounting firm whose decision is binding)
• Who pays for the independent accountant

Consider a Pre-Close Balance Sheet

For complex businesses, preparing a pre-closing estimate of NWC 5-10 days before closing gives both parties a preview and reduces post-close surprises.

Working Capital in Different Industries

Working capital dynamics vary significantly by industry:

Service businesses typically have low working capital — minimal inventory, short receivable cycles, and limited prepaids. The peg is usually small relative to enterprise value.

Distribution and wholesale businesses have high working capital due to inventory and receivables. The peg can be 15-25%+ of revenue, making the adjustment a major deal term.

Manufacturing businesses fall in between, with working capital driven by inventory, WIP, and receivable terms. Seasonal production cycles add complexity.

Subscription/SaaS businesses often have negative working capital because of deferred revenue (customers pay upfront). This creates a counterintuitive dynamic where the buyer benefits from the liability, and the peg needs careful handling.

Construction businesses have complex working capital due to overbillings, underbillings, retainage, and WIP. These require specialized accounting treatment.

The Bottom Line

The working capital peg isn't a minor technicality — it's a core economic term that directly impacts your net proceeds. Treat it with the same attention you give to the purchase price.

If you're preparing for a sale and want to understand how working capital dynamics might affect your deal, let's discuss your specific situation.