The higher acquisition offer may not produce higher proceeds. A buyer’s valuation typically assumes that the business will arrive at closing with an agreed level of operating working capital. A shortfall against that requirement can reduce the purchase price, changing the economics of an otherwise attractive proposal.
For middle-market business owners, working capital peg negotiation deserves attention while competing offers are still being evaluated. The target amount matters, but so do the accounts included, the accounting policies applied, and the process for settling differences after closing. Understanding those provisions helps owners judge what an offer is likely to deliver.
A working capital peg is the agreed level of net working capital a seller is expected to deliver at closing. In an acquisition with a conventional working capital adjustment, an excess above the peg increases the purchase price, while a shortfall reduces it, subject to the agreement’s terms.
Net working capital generally means current assets minus current liabilities. An acquisition agreement establishes a transaction-specific definition, often including receivables, inventory, and prepaid operating expenses, less accounts payable and accrued operating expenses. Cash, indebtedness, and items addressed separately in the purchase-price calculation are generally excluded.
The peg represents the operating working capital assumed in the agreed valuation. It is not a separate cash deposit or a requirement to leave the same amount of money in the bank.
Under a dollar-for-dollar adjustment:
Working capital adjustment = Closing net working capital − Working capital peg
If the peg is $2.5 million and closing net working capital is $2.4 million, the purchase price decreases by $100,000. Other adjustments, including cash, debt, and transaction expenses, are addressed separately.
Enterprise value is the negotiated value of the operating business. The amount payable for the seller’s equity generally reflects adjustments for cash, debt, working capital, and other agreed items. Cash received at closing may be lower still because of escrows, deferred consideration, or rollover equity.
That distinction matters when comparing offers:
| Illustrative terms | Offer A | Offer B |
|---|---|---|
| Headline enterprise value | $20.0 million | $19.7 million |
| Working capital peg | $3.0 million | $2.5 million |
| Closing net working capital | $2.4 million | $2.4 million |
| Working capital adjustment | −$600,000 | −$100,000 |
| Value after working capital adjustment, before other adjustments | $19.4 million | $19.6 million |
This hypothetical example assumes identical working capital definitions, dollar-for-dollar adjustments, and otherwise equivalent terms. It excludes cash, debt, transaction expenses, taxes, and other adjustments.
Offer A begins $300,000 higher but produces $200,000 less after the working capital adjustment. Its higher target requires the seller to deliver more operating capital within the headline price.
Actual comparisons can be more complicated because buyers may use different definitions. One might include customer deposits in working capital while another deducts them separately as debt-like obligations. Applying each proposal to the same projected closing balance sheet makes those differences visible.
A letter of intent may leave the final working capital peg subject to diligence. Nevertheless, sellers should seek early alignment on the proposed methodology and significant account classifications before granting exclusivity. Unresolved assumptions can become harder to negotiate once alternative buyers are no longer actively competing.
The discussion should cover the historical measurement period, major inclusions and exclusions, treatment of unusual balances, and whether the adjustment operates in both directions. Even a preliminary calculation can expose disagreements that a general commitment to deliver “normal working capital” leaves unresolved.
Two questions need separate answers: what level of working capital must the seller deliver, and how will the parties measure it? Agreement on the target offers limited protection if the closing calculation applies different rules. The LOI should establish a sufficiently clear commercial framework for the detailed provisions that follow.
A trailing 12-month average is a common starting point because it captures a full annual cycle. Its usefulness depends on reliable monthly reporting and whether the period represents the business being sold. A mathematically accurate average can still produce an inappropriate target.
Seasonality requires particular care. A distributor building inventory ahead of its busiest quarter may carry substantially more working capital than it does after the selling season. Sellers should model likely closing dates against the proposed peg and understand the resulting adjustments. Depending on the business, the parties may negotiate a seasonal target or another supported approach.
Growth also requires judgment. Historical receivables and inventory may understate the needs of a business operating at a larger scale. Conversely, better collections or inventory management may reduce working capital requirements despite rising revenue. Any adjustment to the target should be linked to documented operating changes.
Reviewing 18 to 24 months of monthly balances can help identify recurring patterns and unusual events, without necessarily averaging every month into the peg. Older periods may be less representative following an acquisition or a change in customer terms. A schedule reconciled to the financial statements, supported by receivables aging, inventory reserves, and explanations of material fluctuations, provides a stronger negotiating foundation than an unsupported target.
The treatment of individual accounts can matter as much as the peg itself. Receivables may require reserves for doubtful collection, inventory may need adjustments for obsolescence, and accrued expenses may contain obligations addressed elsewhere in the transaction.
An expense’s treatment as an EBITDA add-back does not automatically determine how its unpaid liability should be handled. A seller may have a valid earnings add-back for a non-recurring expense while still needing to address the associated payment obligation in the purchase-price calculation.
Classification can also change the economic result. Suppose a recurring $200,000 liability appears in both the historical peg and closing working capital at the same amount. It creates no variance by itself. If the parties instead exclude it from both calculations and deduct it separately as debt-like, seller proceeds fall by $200,000, assuming no offsetting change to the negotiated price.
That is why a proposed reclassification should be evaluated across the entire calculation. The parties need to understand its effect on the peg, closing working capital, and any separate deductions, while preventing the same obligation from being counted twice.
Deferred revenue creates a particular commercial issue: the seller may retain cash collected before closing while the buyer assumes the remaining performance obligation. The negotiation concerns how that obligation is reflected in the price and how it should be measured.
Depending on the agreement, the balance may be incorporated into working capital or addressed separately as a debt-like item. A cost-to-fulfill approach may be proposed, but it requires support for the remaining costs. Applying a historical gross margin mechanically can overlook continuing support, delivery, or other obligations.
The agreed treatment should specify how the liability affects both the target and the closing calculation. The account label alone does not resolve the economics.
The purchase agreement should establish which rules prevail when specific negotiated policies, historical accounting practices, and generally accepted accounting principles differ.
For example, the peg might reflect the company’s historical inventory reserve while the closing statement applies a more conservative reserve methodology. That change could reduce closing working capital even without a corresponding deterioration in inventory. The agreement should resolve whether such a change is permitted before the parties sign.
An illustrative calculation attached to the agreement can make the provisions easier to apply. Mapping relevant general ledger accounts and specifying reserve policies, exclusions, and cutoff rules gives both sides a practical reference.
Working capital continues to change as the company collects receivables, buys inventory, pays suppliers, and incurs expenses. Management should understand how those movements affect the closing estimate while operating within the agreement’s ordinary-course requirements.
Delaying supplier payments, for example, preserves cash but leaves higher accounts payable. Where cash is excluded from transaction working capital, that higher liability reduces net working capital, all else equal. The effect on proceeds therefore requires examining both cash treatment and the working capital adjustment.
The seller’s priority should be maintaining normal operations and documenting material departures. An unusual inventory purchase or customer payment is easier to explain when its commercial rationale is recorded before closing.
The initial purchase-price calculation commonly uses an estimate of closing working capital. A post-closing statement then measures the balance as of the agreed closing time under the contractual methodology. The true-up reconciles that final amount with the estimate already used.
For example, estimated working capital of $2.4 million against a $2.5 million peg produces an initial $100,000 reduction. If final working capital is $2.45 million, the shortfall is only $50,000. The true-up would therefore return $50,000 to the seller, assuming no other adjustments or limitations.
The true-up measures the business’s position at closing. It does not ordinarily compensate the buyer for subsequent operating results, although later collections or other evidence may inform the measurement of closing balances where the agreed methodology permits.
The agreement should distinguish the statement-delivery deadline from the seller’s review period, the negotiation period, and any independent-accountant process. It should also provide access to the records needed to review the calculation and define the accountant’s authority over unresolved items.
If the agreement includes an adjustment threshold or collar, determine whether it operates as a tipping threshold or a deductible. The difference can materially affect the payment.
Escrow accounts and holdbacks require separate analysis. Both can secure potential post-closing payments, but escrow funds are held by a third party, while a holdback remains with the buyer. Neither arrangement necessarily caps the seller’s exposure. The amount retained, release conditions, and any separate liability limit should be reviewed together.
A working capital target becomes commercially meaningful when applied to the company’s expected closing position. Before granting exclusivity, sellers should ask their advisers to calculate expected proceeds under each serious offer using the same projected closing balance sheet. That exercise can reveal differences the headline valuations obscure.
It also provides a basis for constructive negotiation. A buyer may have sound reasons to question a historical average or reserve policy. The seller should be able to assess the concern using the company’s records and quantify the proposed change.
Versailles Group’s sell-side M&A advisory helps business owners evaluate competing proposals and negotiate the commercial terms that shape a transaction. Working alongside legal and accounting advisers, the process includes assessing how working capital requirements affect the value and timing of seller proceeds. Contact Versailles Group to discuss your sale objectives and proposed transaction terms.
In many cash-free, debt-free transactions, the agreed enterprise value assumes delivery of a normal level of operating working capital. The peg defines that level, and the agreement determines how an excess or shortfall affects the purchase price.
Yes. Some businesses routinely collect from customers before paying suppliers or delivering services, producing negative operating working capital. The peg should reflect the business model and agreed account definitions. Closing working capital of negative $400,000 is $100,000 above a negative $500,000 peg.
With identical definitions and otherwise unchanged terms, a lower peg produces a more favorable adjustment. Across competing offers, however, differences in headline price, debt-like deductions, accounting policies, and other terms may outweigh that benefit. Sellers should compare the complete proceeds calculation.