A working-capital peg is the agreed normalized net working capital a business is expected to deliver at closing. Closing working capital is compared with that target under the purchase agreement. A shortfall may reduce proceeds and an excess may increase them, subject to the agreement’s definitions. Inclusions, exclusions, measurement rules, and true-up procedures are transaction-specific and should be resolved early. EisnerAmper, “Net Working Capital and Key Considerations for Buyers and Sellers Contemplating a Transaction,” July 25, 2024.
A peg is not the same thing as business valuation. Valuation addresses what the business may be worth; a working-capital provision addresses the operating capital expected to remain in the business at closing and can affect the final transaction economics.
For the broader seller journey, see how SeaRidge Advisory approaches selling a business through a negotiated process.
What Is a Working Capital Peg in a Business Sale?
Transaction net working capital versus balance-sheet working capital
Net working capital generally starts with current assets less current liabilities. In a transaction, however, the parties define the specific assets, liabilities, accounting policies, and adjustments used for the closing calculation. That negotiated transaction definition may differ from a broad balance-sheet presentation. Whiteford, Taylor & Preston LLP, “Net Working Capital & Purchase Price Adjustments In M&A Deals,” September 18, 2024.
How cash-free, debt-free structure relates to the peg
Many transactions are described as cash-free and debt-free, but the treatment of cash, debt, debt-like items, and working-capital accounts depends on the agreement. The seller should not assume that every transaction follows the same structure or that a balance-sheet label settles the issue. The definitions need to work together without creating gaps or double counting. EisnerAmper, July 25, 2024; Whiteford, Taylor & Preston LLP, September 18, 2024.
What Is Included in Net Working Capital?
Common operating current assets
Accounts receivable, inventory, prepaid expenses, and other operating current assets may be considered in a transaction working-capital calculation. Whether an item is included, and how its quality is measured, remains a matter of the negotiated definition and the company’s records.
Common operating current liabilities
Accounts payable, accrued expenses, deferred revenue, and other operating current liabilities may be considered as well. The agreement should make clear how each material category is treated and whether related items are addressed elsewhere in the purchase-price structure.
Why exclusions and classifications vary by agreement
Cash, debt, non-operating assets, transaction expenses, personal items, aged receivables, inventory issues, customer credits, vendor credits, and similar items can require specific treatment. The relevant question is not what another transaction included. It is what this agreement defines and how that definition is applied consistently. EisnerAmper, July 25, 2024.
| Potential operating assets | Potential operating liabilities | Commonly negotiated exclusions or classification questions |
|---|---|---|
| Accounts receivable, inventory, prepaid expenses | Accounts payable, accrued expenses, deferred revenue | Cash, debt, debt-like items, transaction expenses, non-operating or personal items |
| Asset quality, collectability, and timing may require review | Completeness, timing, and proper accrual may require review | Treatment is deal-specific and should be defined in the agreement |
How Is the Working Capital Target Set?
Historical averages and representative periods
A target is often informed by historical working-capital performance, but the relevant period and methodology should reflect the company and the deal. Historical averages can be useful only when the underlying periods are representative and the calculation uses agreed definitions. Whiteford, Taylor & Preston LLP, September 18, 2024.
Seasonality, growth, and unusual periods
Seasonality, growth, customer terms, inventory cycles, unusual collections, and one-time events can make a simple average misleading. Test the periods that drive the proposed target and write down why they are or are not representative. EisnerAmper notes that the period used to establish a peg can vary with business cyclicality, seasonality, and other factors. EisnerAmper, July 25, 2024.
Accounting consistency and normalization
Closing working capital is easier to compare with the target when the same accounting policies, practices, classifications, and timing conventions are understood in advance. If the company’s monthly records differ from year-end or audited practices, identify that issue before the target is finalized. Whiteford, Taylor & Preston LLP, September 18, 2024.
How the Peg Can Change a Seller’s Closing Proceeds
Delivering above or below the agreed target
The purchase agreement determines how the comparison works. Under an agreement that provides for an adjustment, final working capital above the target can increase consideration and final working capital below the target can reduce it. Some agreements may include other negotiated mechanics, so sellers should focus on the actual language rather than assume a universal dollar-for-dollar result. EisnerAmper, July 25, 2024.
A clearly illustrative calculation
Closing estimates and post-closing true-ups
A closing estimate and a post-closing true-up are distinct. The parties may use an estimate near closing, then compare a final closing-date calculation with the agreed target after closing under the agreement’s process. The documents should address the calculation, information access, timing, and how disagreements are handled. Whiteford, Taylor & Preston LLP, September 18, 2024.
Where Working Capital Appears in the Deal Documents
Letter of intent
The letter of intent is the right place to identify the parties’ general working-capital intent early: whether a peg will apply, the expected framework, and the material issues requiring definition. Early alignment can reduce the risk that a basic definition dispute appears after the business has moved deeper into diligence. EisnerAmper, July 25, 2024.
Purchase agreement
The purchase agreement should contain the operative definition, included and excluded accounts, accounting principles, calculation methodology, target, closing estimate, final calculation process, and any negotiated adjustment provisions. These are legal and accounting matters that should be reviewed with qualified transaction advisers.
Closing statement and dispute process
The closing statement applies the agreed framework to the transaction. Sellers should understand who prepares each calculation, what supporting records are available, how objections are raised, and how unresolved differences are addressed. Whiteford notes that definitive agreements commonly set a post-closing dispute-resolution process for working-capital disagreements. Whiteford, Taylor & Preston LLP, September 18, 2024.
What Sellers Should Prepare Before Signing the LOI
Reconcile accounts and classifications
Reconcile the accounts likely to enter the discussion and identify differences between operating reports, financial statements, and historical practices. The goal is not to produce a broad diligence checklist; it is to understand the accounts and classifications that could change the peg calculation.
Test trends, seasonality, and growth
Review historical periods for seasonality, growth, unusual collections, inventory movement, customer-term changes, or other events that could make a target unrepresentative. This work complements, rather than replaces, broader quality of earnings preparation.
Identify likely definition disputes
Flag accounts that invite different treatment: aged receivables, excess or obsolete inventory, deferred revenue, customer deposits, accrued expenses, related-party items, transaction costs, and cash or debt-like classifications. Raise the question before the agreement locks in a definition.
Questions Sellers Should Resolve Before Agreeing to a Peg
- What exact accounts are included and excluded?
- Which historical periods support the target, and are they representative?
- Which accounting policies and practices apply to both the target and closing calculation?
- How are seasonality, growth, unusual periods, and asset quality addressed?
- Who prepares the closing estimate and final calculation?
- What information and records can the seller review after closing?
- How are objections, disputes, setoffs, and final adjustments handled?
- Which legal, accounting, and tax questions need advice before the LOI or purchase agreement is signed?
Get Seller-Side Advice Before Finalizing the Transaction Structure
A working-capital peg is a transaction term that can affect final proceeds, but it is not a substitute for valuation and should not be treated as a boilerplate detail. Sellers are best served by understanding the target, the definitions behind it, the historical evidence, and the true-up process before those terms become difficult to change.
Sources and Scope
- EisnerAmper, “Net Working Capital and Key Considerations for Buyers and Sellers Contemplating a Transaction,” July 25, 2024
- Whiteford, Taylor & Preston LLP, “Net Working Capital & Purchase Price Adjustments In M&A Deals,” September 18, 2024
This article provides general seller-side education, not legal, accounting, or tax advice. Transaction-specific terms should be reviewed with qualified advisers.