Working Capital Peg in M&A: How It Affects Purchase Price

In an M&A transaction, the headline purchase price is rarely the exact amount a seller ultimately receives at closing. Between Enterprise Value and final equity proceeds, several adjustments can materially change the economics of a deal. One of the most important—and frequently negotiated—is the working capital adjustment.

At the center of that adjustment is the working capital peg, sometimes referred to as the target working capital or normalized net working capital target.

The concept appears straightforward: determine how much working capital the business normally requires, establish that amount as the target, and compare it with actual working capital at closing.

In practice, however, determining an appropriate working capital peg can become one of the most technically challenging and commercially sensitive parts of an acquisition.

A difference of even a few million dollars in the agreed working capital target can translate almost dollar-for-dollar into a change in seller proceeds.

Working capital analysis is therefore closely connected with financial due diligence, Quality of Earnings analysis, purchase price negotiations, and the bridge from Enterprise Value to Equity Value.

What Is a Working Capital Peg in M&A?

A working capital peg is the agreed level of normalized net working capital that a seller is generally expected to deliver with the business at closing.

The fundamental principle is simple:

A buyer purchasing an operating business generally expects to receive enough operating working capital for the company to continue functioning normally immediately after closing.

Without a working capital mechanism, a seller could potentially increase pre-closing cash proceeds by:

Accelerating collection of accounts receivable
Allowing inventory to decline below normal operating levels
Delaying payments to suppliers
Deferring ordinary operating expenses
Changing normal billing or collection practices

The buyer could then acquire a business requiring an immediate cash injection simply to restore normal operations.

The working capital peg is designed to reduce this economic distortion.

Simple Working Capital Peg Example

Suppose historical analysis indicates that a business normally requires:

$10 million of net working capital

The buyer and seller therefore agree on:

Working Capital Peg = $10 million

At closing, qualifying net working capital is determined to be:

$9 million

The company has therefore delivered:

$1 million less working capital than the agreed target.

Subject to the definitions and adjustment mechanics contained in the purchase agreement, the purchase price may consequently be reduced by approximately:

$1 million

If closing working capital were instead $11 million, the seller could potentially receive a $1 million upward adjustment, depending on the terms of the transaction.

Illustrative Working Capital Adjustment

Item	Amount
Working Capital Peg	$10.0M
Closing Net Working Capital	$9.0M
Working Capital Shortfall	($1.0M)
Potential Purchase Price Adjustment	($1.0M)

This mechanism helps ensure that the buyer receives the operating business at an agreed level of working capital rather than benefiting or suffering from unusual pre-closing balance-sheet movements.

Why Working Capital Matters in an Acquisition

Working capital represents capital tied up in the company’s day-to-day operating cycle.

A profitable company can still require substantial working capital to operate.

For example, consider a rapidly growing distributor.

The business may need to:

Purchase inventory.
Hold that inventory until products are sold.
Provide customers with 30- or 60-day payment terms.
Pay employees and other operating expenses.
Pay suppliers before all customer receivables have been collected.

That timing difference creates a funding requirement.

Consequently, EBITDA alone does not tell a buyer how much capital will be required to operate the acquired company.

A business may generate strong EBITDA but consume significant cash through receivables and inventory growth. Conversely, companies with customer prepayments or favorable supplier terms may operate with relatively low—or even negative—net working capital.

This is one of the reasons buyers examine working capital alongside earnings during financial due diligence.

What Is Net Working Capital in M&A?

Traditional accounting often defines working capital broadly as:

Current Assets − Current Liabilities

For M&A purposes, however, that definition is often too broad.

Transaction net working capital generally focuses on operating current assets and operating current liabilities required to run the business.

A simplified transaction formula is:

Net Working Capital = Operating Current Assets − Operating Current Liabilities

Common Operating Current Assets

Accounts receivable
Inventory
Prepaid operating expenses
Certain other operating current assets

Common Operating Current Liabilities

Accounts payable
Accrued payroll
Accrued operating expenses
Certain operating accruals
Other qualifying current operating liabilities

However, not every current asset or liability necessarily belongs in transaction working capital.

This distinction is especially important when determining whether a balance should be treated as working capital, cash, debt, or a debt-like item.

Why Cash Is Usually Excluded from Net Working Capital

Many acquisitions are structured on a cash-free, debt-free basis.

Under this framework, cash is generally addressed separately when converting Enterprise Value into Equity Value rather than being included in net working capital.

Illustrative Transaction Bridge

Item	Amount
Enterprise Value	$100M
Add: Cash	$5M
Less: Debt	($15M)
Working Capital Adjustment	($2M)
Indicative Equity Proceeds	$88M

Including cash again within working capital could create an inappropriate double count.

Understanding this distinction is important when analyzing Enterprise Value and Equity Value and determining the amount ultimately payable to shareholders.

Why Debt Is Usually Excluded

Conventional debt is generally addressed separately through the Enterprise Value-to-Equity Value bridge.

Examples may include:

Bank loans
Revolving credit facilities
Term loans
Certain shareholder loans
Other financing obligations

Including conventional debt in both net debt and working capital could result in double counting.

The more difficult issues arise with liabilities that are not obviously conventional debt but may nevertheless be considered debt-like items.

Examples may include certain:

Unpaid transaction expenses
Accrued bonuses
Deferred consideration
Tax liabilities
Capital expenditure obligations
Customer-related liabilities
Litigation-related obligations

Whether a particular item belongs in working capital, debt-like items, or another purchase-price adjustment depends on the specific transaction and the definitions contained in the purchase agreement.

This classification can materially affect transaction value and is one of the reasons detailed financial diligence is important before closing.

What Does Normalized Working Capital Mean?

The objective is generally not simply to use working capital from the latest available balance sheet.

Instead, the parties attempt to determine the normal level of operating working capital required to support the business.

This is commonly referred to as normalized net working capital.

Suppose a company reports net working capital of $7 million at year-end.

That does not automatically mean $7 million should become the peg.

Financial diligence may reveal that:

Average monthly working capital was $10 million.
December collections were unusually high.
Inventory was temporarily reduced before year-end.
Several large supplier invoices remained unpaid.
The business had grown materially during the year.

In that situation, the year-end balance may not represent the company’s normal operating requirement.

A professional working capital analysis therefore generally examines historical monthly balances and operating trends rather than relying solely on a single point in time.

How Is a Working Capital Peg Calculated?

There is no universal formula that produces the appropriate working capital peg for every transaction.

A common starting point is historical average net working capital.

Illustrative Monthly Working Capital

Month	Net Working Capital
January	$8.8M
February	$9.1M
March	$9.3M
April	$9.5M
May	$9.7M
June	$9.9M
July	$10.1M
August	$10.4M
September	$10.5M
October	$10.7M
November	$10.9M
December	$11.1M

A simple average provides an initial reference point.

However, immediately accepting that average as the peg may be inappropriate.

The trend clearly indicates that working capital requirements are increasing.

If revenue has also grown significantly, an average incorporating older, lower operating levels could understate the amount of working capital required at closing.

The analyst therefore needs to understand why working capital changed, rather than merely calculating an average.

Common Methods Used to Establish the Working Capital Peg

1. Trailing Twelve-Month Average

One common starting point is the average monthly net working capital over the previous twelve months.

This method can be useful for relatively stable businesses without significant growth or seasonality.

However, it may become misleading when operating conditions have materially changed.

2. Recent-Month Average

For a rapidly growing company, greater emphasis may be placed on more recent months, such as the latest three or six months.

This can better reflect the company’s current operating scale.

However, using too short a period can allow temporary fluctuations to distort the target.

3. Seasonally Adjusted Working Capital

Highly seasonal businesses require additional analysis.

A retailer preparing for a major selling season, for example, may carry substantially more inventory immediately before peak demand than during other periods.

Using a full-year average for a transaction closing during peak season could materially understate the working capital required to operate the business.

4. Working Capital as a Percentage of Revenue

Analysts may also examine working capital relative to revenue.

Period	Revenue	Average NWC	NWC as % of Revenue
Year 1	$80M	$8M	10.0%
Year 2	$100M	$10M	10.0%
Year 3	$120M	$12M	10.0%

If the company consistently requires approximately 10% of revenue as working capital, current or projected revenue may provide useful evidence when evaluating the appropriate target.

However, this percentage should not be applied mechanically. Changes in payment terms, inventory strategy, customer mix, supplier terms, or operating model may alter the relationship.

Working Capital Peg vs. Closing Working Capital

This distinction is fundamental to understanding the adjustment mechanism.

Working Capital Peg

The working capital peg represents the agreed normalized target.

Closing Working Capital

Closing working capital represents the qualifying net working capital actually delivered at closing, calculated according to the definitions and accounting principles established in the purchase agreement.

A simplified relationship is:

Working Capital Adjustment = Closing NWC − Working Capital Peg

Example

Assume:

Working Capital Peg: $15 million
Closing NWC: $13 million

The adjustment is:

$13M − $15M = −$2M

The seller has delivered a $2 million shortfall relative to the target.

Alternatively:

Working Capital Peg: $15 million
Closing NWC: $17 million

The adjustment becomes:

$17M − $15M = +$2M

The seller has delivered $2 million more qualifying working capital than the target.

Whether adjustments operate on a fully dollar-for-dollar basis or are subject to thresholds, collars, caps, or other contractual mechanisms depends on the purchase agreement.

How a Working Capital Peg Can Change Seller Proceeds

This is where working capital analysis becomes commercially important.

Imagine that the buyer and seller agree on an Enterprise Value of:

$150 million

The seller may initially focus heavily on negotiating that headline valuation.

However, assume the parties disagree about normalized working capital.

Seller Position

Working Capital Peg = $8 million

Buyer Position

Working Capital Peg = $11 million

Difference:

$3 million

If closing working capital is $8 million and the buyer-supported $11 million peg is ultimately agreed, the seller may face approximately a $3 million downward adjustment.

Item	Seller Position	Buyer Position
Working Capital Peg	$8M	$11M
Closing NWC	$8M	$8M
Adjustment	$0	($3M)

The Enterprise Value did not change.

Yet the seller’s potential proceeds changed by $3 million.

This is why working capital is one of the important areas buyers examine during financial due diligence.

Working Capital Peg vs. Purchase Price

A common misunderstanding is that the working capital peg represents an additional amount that the buyer pays for the business.

Usually, that is not the correct way to view the mechanism.

The negotiated Enterprise Value generally assumes that the business will be delivered with a normal level of operating working capital.

The peg establishes the benchmark used to determine whether the seller delivered that assumed level.

Therefore, the working capital mechanism generally functions as a true-up mechanism rather than a separate valuation of working capital.

This distinction matters because working capital forms part of the operating platform required to generate the earnings on which the Enterprise Value was negotiated.

Buyer Perspective on the Working Capital Peg

The buyer generally wants to ensure that:

Adequate receivables transfer with the business.
Inventory is sufficient and usable.
Supplier obligations have not been artificially deferred.
Operating accruals are appropriately recorded.
The company can operate normally immediately after closing.
The buyer does not need to inject unexpected cash immediately after acquisition.

A buyer may therefore support a higher peg when historical evidence demonstrates that the business normally requires a higher level of operating working capital.

Seller Perspective on the Working Capital Peg

The seller generally wants to ensure that:

The peg does not exceed the company’s actual normalized requirement.
Unusual historical periods do not inflate the target.
Growth is treated consistently with transaction assumptions.
Non-operating liabilities are not improperly included.
Debt-like items are not counted twice.
Seasonality is appropriately considered.
The same accounting principles are applied to both the peg and closing calculation.

Neither side’s preferred number is automatically correct.

The appropriate peg should be supported by historical financial data, current operating conditions, expected closing conditions, transaction definitions, and the economic requirements of the business.

Why Working Capital Peg Analysis Is Part of Financial Due Diligence

Working capital analysis is closely connected with broader financial due diligence and Quality of Earnings analysis.

A buyer is not simply asking:

“What was working capital last month?”

The more important questions include:

What is the normal working capital requirement?
How has it changed historically?
Is the business seasonal?
Is revenue growing or declining?
Are receivable collection periods changing?
Is inventory accumulating?
Have supplier payment terms changed?
Are liabilities fully accrued?
Are any balances debt-like rather than operating?
Are there unusual or non-recurring balances?
Does closing working capital use the same accounting principles as the peg?

These questions help determine whether the proposed working capital target reflects the actual operating economics of the business.

Key Takeaway

A working capital peg is not merely an accounting calculation. It is a transaction mechanism that can directly affect the amount ultimately paid or received in an M&A transaction.

Establishing an appropriate peg requires understanding historical working capital, seasonality, growth, accounting classifications, operating requirements, cash and debt treatment, and the definitions contained in the purchase agreement.

For buyers, a properly structured working capital mechanism helps ensure that the acquired business has sufficient operating capital immediately after closing.

For sellers, careful analysis can help prevent an unnecessarily high target from reducing transaction proceeds.

Because working capital adjustments can materially affect purchase price, they should be evaluated alongside financial due diligence, normalized earnings, debt-like items, and the Enterprise Value-to-Equity Value bridge.

Which Accounts Should Be Included in Net Working Capital?

One of the most important steps in establishing a working capital peg is determining exactly which balance sheet accounts belong in the net working capital calculation.

This may sound straightforward, but in M&A transactions the classification of individual accounts can materially affect the purchase price adjustment.

The starting point is usually to identify operating current assets and operating current liabilities that are required to support the normal day-to-day operation of the business.

However, transaction working capital is not simply copied from the balance sheet. Each account should be evaluated based on its economic nature, transaction treatment, and the definitions contained in the purchase agreement.

Accounts Receivable

Accounts receivable are commonly included in net working capital because they represent amounts owed by customers for goods or services already delivered.

For many businesses, receivables are one of the largest operating working capital accounts.

However, buyers should analyze the quality of those receivables rather than relying solely on the gross balance.

Key Accounts Receivable Questions

How quickly are customers paying?
Are Days Sales Outstanding increasing?
Are there significant balances over 90 days?
Are any receivables disputed?
Are bad debt reserves sufficient?
Were any collections accelerated before closing?

These questions are closely connected with financial due diligence and Quality of Earnings analysis because weak collections can reduce the economic quality of reported revenue.

Illustrative Receivable Aging

Aging Category	Amount
Current	$6.0M
31–60 Days	$2.5M
61–90 Days	$1.2M
90+ Days	$1.8M
Total Accounts Receivable	$11.5M

If a material portion of the receivable balance is unlikely to be collected, the buyer may challenge whether the full amount should be included in closing working capital.

Inventory

Inventory is commonly included in net working capital for manufacturing, distribution, retail, and other inventory-intensive businesses.

However, the economic quality of inventory can be just as important as the reported balance.

Buyers may examine:

Inventory turnover
Slow-moving inventory
Obsolete stock
Excess inventory
Write-down policies
Seasonal inventory requirements

Example: Obsolete Inventory

Assume the balance sheet reports:

Inventory = $8 million

Financial diligence determines that approximately $1 million of inventory is obsolete and unlikely to be sold at carrying value.

The buyer may argue that normalized operating inventory should be closer to:

$7 million

This adjustment can affect both working capital and the perceived quality of the company’s balance sheet.

Prepaid Expenses

Prepaid expenses may be included in net working capital when they represent ordinary operating expenditures that benefit the post-closing business.

Examples may include:

Prepaid insurance
Software subscriptions
Maintenance contracts
Rent
Other recurring operating expenses

However, not all prepaid items automatically belong in working capital.

A prepaid transaction expense, for example, may be treated separately because it relates to the sale process rather than normal business operations.

Other Operating Current Assets

Certain other current assets may also qualify as operating working capital depending on the nature of the business.

Examples may include:

Employee advances
Supplier deposits
Short-term operating deposits
Other recurring current operating assets

Each item should be evaluated based on whether it is necessary to operate the business after closing.

Accounts Payable

Accounts payable are typically included as an operating current liability.

They represent amounts owed to suppliers for goods and services used in normal operations.

However, buyers should analyze whether payables have been managed consistently with historical practices.

Red Flags in Accounts Payable

Large increase in overdue supplier balances
Delayed vendor payments before closing
Unrecorded supplier invoices
Changes in payment terms
Supplier disputes

A seller may temporarily increase cash by delaying payments to suppliers, but this can artificially reduce closing net working capital quality.

Accrued Operating Expenses

Accrued operating expenses are commonly included in net working capital when they relate to normal recurring business activities.

Examples may include:

Accrued payroll
Employee benefits
Utilities
Professional fees
Sales commissions
Other recurring operating accruals

These liabilities should generally reflect the expenses required to operate the business through the closing date.

Accrued Payroll

Accrued payroll is usually an operating liability because employees have already earned compensation that remains unpaid at the measurement date.

However, special attention may be required for:

Annual bonuses
Transaction bonuses
Retention bonuses
Change-of-control payments

Some of these amounts may be considered ordinary working capital liabilities, while others may be treated as debt-like or seller-specific transaction obligations.

The appropriate classification depends on the nature of the obligation and the purchase agreement.

Deferred Revenue

Deferred revenue is one of the more complex working capital items in M&A.

It typically represents cash already collected for products or services that the company has not yet fully delivered.

From an accounting perspective, deferred revenue is a liability.

From a transaction perspective, however, the buyer may inherit the future obligation to provide goods or services without receiving the associated cash because the seller collected it before closing.

Illustrative Example

Assume a software company has:

Deferred Revenue: $5 million
Cash already collected by seller: $5 million
Future cost to service customers: $1.5 million

The treatment of deferred revenue can therefore materially affect the transaction economics.

Depending on the deal structure, deferred revenue may be:

Included fully in working capital
Included partially
Adjusted for the future cost to fulfill the obligation
Treated separately in the purchase price mechanism

This is a heavily negotiated area and should be addressed explicitly in the purchase agreement.

Customer Deposits

Customer deposits may create a similar issue.

If the seller has already collected cash but the buyer must deliver the related product or service after closing, the buyer may argue that the associated liability should reduce transaction value.

The appropriate treatment depends on:

The amount of cash received
The cost to fulfill the obligation
The accounting treatment
The purchase agreement definitions

Accrued Bonuses

Accrued bonuses require careful analysis because not every bonus liability should necessarily be treated the same way.

For example:

Ordinary Annual Bonus

An ordinary annual employee bonus related to normal operating performance may be considered part of operating working capital.

Transaction Bonus

A transaction-specific bonus triggered by the sale may be treated as a seller obligation or debt-like item.

Retention Bonus

A retention bonus may require more nuanced treatment depending on whether the employee service period extends beyond closing.

This distinction matters because misclassification can result in the same liability affecting purchase price twice or not at all.

Taxes

Tax liabilities are another area that requires careful classification.

Some taxes may be ordinary operating working capital items, while others may be excluded from net working capital and treated separately.

Potential examples include:

Payroll taxes
Sales taxes
VAT/GST liabilities
Income taxes
Property taxes

Income tax liabilities, in particular, are often treated separately from operating working capital depending on the transaction structure.

Transaction Expenses

Transaction expenses are generally not considered normal operating working capital.

Examples may include:

Investment banking fees
Legal transaction fees
Transaction accounting fees
Seller advisory fees
Deal-related success fees

These are commonly treated as seller-specific obligations or debt-like items rather than operating working capital.

This distinction is important when analyzing Enterprise Value, Equity Value, and final seller proceeds.

Debt-Like Items vs. Working Capital

One of the most difficult transaction issues is distinguishing a normal working capital liability from a debt-like item.

A working capital liability generally:

Arises in the normal operating cycle
Reverses or renews regularly
Is necessary to support ongoing operations

A debt-like item generally:

Represents a financing obligation
Relates to a non-operating event
Represents a liability that economically belongs to the seller
May require settlement after closing without generating future operating benefit

Illustrative Classification

Item	Typical Treatment
Accounts Payable	Working Capital
Accrued Payroll	Working Capital
Bank Debt	Debt
Transaction Bonus	Potential Debt-Like Item
Unpaid Deal Fees	Potential Debt-Like Item
Deferred Revenue	Transaction-Specific Treatment

The exact treatment is transaction-specific and should be explicitly documented in the purchase agreement.

Why Double Counting Is a Major Risk

Working capital and debt-like item negotiations should be coordinated carefully.

If a liability is included as a reduction to net working capital and also deducted as debt-like, the seller may effectively be charged twice for the same obligation.

Example

Assume:

Accrued transaction bonus: $1 million

If this amount:

Reduces closing working capital by $1 million, and
Is also deducted as a $1 million debt-like item,

the seller could experience a total $2 million reduction for a $1 million liability.

This is why detailed purchase price bridges and reconciliation schedules are essential.

Consistency Between the Peg and Closing Calculation

One of the most important principles in working capital adjustments is consistency.

The accounts and accounting policies used to determine the peg should generally be consistent with those used to calculate closing working capital.

For example, if the peg historically excludes certain bonus accruals but closing working capital includes them, the seller may be disadvantaged.

Similarly, if inventory reserves are calculated differently at closing than during the historical normalization period, the adjustment may become distorted.

Key Consistency Areas

Account definitions
Accounting policies
Reserve methodologies
Revenue recognition
Inventory accounting
Accrual practices
Cut-off procedures

The purchase agreement often attempts to establish a hierarchy of accounting principles to reduce these disputes.

Seasonality and Account Inclusion

Seasonality can materially affect individual working capital accounts.

For example, a seasonal retailer may build inventory months before its peak selling period.

If the transaction closes just before peak season, normal working capital may be much higher than the annual average.

Likewise, accounts receivable may increase significantly immediately after a seasonal sales period.

Analysts should therefore consider not only which accounts belong in working capital but also whether their balances are normal for the expected closing date.

Growth and Working Capital Requirements

Rapid growth can also change the appropriate working capital peg.

Assume revenue grows from:

Year 1: $80 million
Year 2: $100 million
Year 3: $130 million

If net working capital historically represents approximately 10% of revenue, the company may require:

Year 1: $8 million
Year 2: $10 million
Year 3: $13 million

Using an older historical average of $9 million could materially understate the amount required to operate the current business.

How Quality of Earnings Connects with Working Capital

Working capital analysis is closely connected with Quality of Earnings because both attempt to determine whether reported financial performance reflects sustainable business economics.

For example:

Revenue growth with weak collections may increase accounts receivable.
Temporary supplier payment delays may improve cash flow but increase accounts payable.
Deferred maintenance may artificially improve EBITDA while creating future cash requirements.
Inventory accumulation may indicate weakening demand.

These issues can affect both normalized earnings and the working capital peg.

For a broader transaction perspective, see What Buyers Examine During Financial Due Diligence.

Working Capital Inclusion Checklist

When evaluating whether an account belongs in net working capital, buyers and sellers should consider:

Is the item part of normal operations?
Does it recur regularly?
Will the buyer receive the economic benefit?
Will the buyer inherit the obligation?
Is the item already reflected in debt or another purchase price adjustment?
Was the account historically included when calculating the peg?
Is the accounting policy consistent at closing?

Key Takeaway

The working capital peg is only as reliable as the account definitions underlying it.

Accounts receivable, inventory, prepaid operating expenses, accounts payable, and ordinary operating accruals are commonly included, while cash, conventional debt, and transaction-specific liabilities are often treated separately.

The difficult areas—such as deferred revenue, customer deposits, bonuses, taxes, and debt-like items—require detailed transaction analysis.

Buyers and sellers should focus on economic substance, avoid double counting, and ensure that the same accounting principles are used when calculating both the normalized peg and closing working capital.

These classifications can materially affect the final purchase price, making working capital analysis an important component of financial due diligence and broader M&A transaction analysis.

How Seasonality Affects the Working Capital Peg

Seasonality is one of the most important factors to consider when establishing a working capital peg in an M&A transaction.

A simple trailing twelve-month average may be reasonable for a stable business, but it can produce a misleading target for companies whose receivables, inventory, payables, or operating accruals fluctuate significantly during the year.

For seasonal businesses, the key question is not simply:

“What is average working capital?”

The more relevant question is:

“What level of working capital is normal for the period in which the transaction is expected to close?”

Example of Seasonal Working Capital

Consider a retailer that builds inventory during the months leading up to the holiday season.

Month	Net Working Capital
January	$6.0M
February	$6.2M
March	$6.4M
April	$6.8M
May	$7.1M
June	$7.4M
July	$8.0M
August	$9.0M
September	$10.5M
October	$12.0M
November	$13.5M
December	$8.5M

The annual average may be materially lower than the level of working capital normally required in October or November.

If a transaction closes during the company’s peak inventory build, using a full-year average could understate the amount of capital required to support the business immediately after closing.

Methods for Adjusting the Peg for Seasonality

1. Same-Period Historical Average

One approach is to compare the anticipated closing month with the same month in prior years.

For example, if closing is expected in October, the analyst may review October working capital over the previous three years rather than relying solely on a twelve-month average.

2. Seasonal Monthly Peg

In some transactions, the parties may establish different working capital targets depending on the actual month of closing.

For example:

Closing Month	Illustrative Peg
September	$10.5M
October	$12.0M
November	$13.0M
December	$9.0M

This approach can reduce the risk that delays in closing create an unintended economic benefit for either party.

3. Rolling Historical Analysis

Analysts may also examine multiple years of monthly data to identify recurring seasonal patterns and unusual periods.

This can help distinguish genuine seasonality from one-time working capital fluctuations.

How Rapid Growth Affects the Working Capital Peg

Growth can create a different problem.

When a company is expanding quickly, older historical working capital balances may no longer reflect the scale of the business at closing.

Assume:

Year	Revenue	Average NWC	NWC as % of Revenue
Year 1	$70M	$7.0M	10.0%
Year 2	$90M	$9.0M	10.0%
Year 3	$120M	$12.0M	10.0%

If the company’s current annualized revenue has reached $140 million, a peg based on an older $9 million historical average could materially understate current operating requirements.

In such cases, the analyst may consider:

Recent-month working capital
Working capital as a percentage of revenue
Updated operating forecasts
Changes in payment terms
Changes in customer or supplier mix

Growth Should Be Treated Consistently with Valuation

One of the most important negotiation principles is consistency between the assumptions used to value the business and those used to establish the working capital peg.

For example, if the buyer values the company based on a rapidly growing revenue forecast but argues for a peg based on much lower historical operating levels, the seller may challenge the inconsistency.

Similarly, sellers should not rely on high growth assumptions to support valuation while simultaneously arguing that working capital requirements will remain unchanged.

The transaction economics should be internally consistent.

How Accounts Receivable Trends Affect the Peg

Accounts receivable can significantly influence normalized working capital, particularly when customer payment behavior changes over time.

Example

Year	Revenue	Accounts Receivable
Year 1	$80M	$10M
Year 2	$100M	$14M
Year 3	$120M	$20M

Receivables have increased faster than revenue.

This may indicate:

Longer customer payment terms
Collection problems
Changes in customer mix
Aggressive revenue recognition

A buyer may therefore argue that the higher receivable balance reflects the company’s current operating requirements rather than a temporary anomaly.

These trends should also be considered as part of financial due diligence because deteriorating collections can affect both working capital and cash conversion.

Days Sales Outstanding and Working Capital

Days Sales Outstanding, or DSO, can help explain changes in receivables.

Suppose DSO increases from:

Year 1: 45 days
Year 2: 52 days
Year 3: 61 days

Even if revenue growth is strong, the business is taking longer to convert sales into cash.

This may increase the appropriate working capital requirement and can also signal a deterioration in earnings quality.

Inventory Trends and the Working Capital Peg

Inventory can create similar issues.

For example:

Year	Revenue	Inventory
Year 1	$90M	$9M
Year 2	$100M	$12M
Year 3	$110M	$18M

Inventory has doubled while revenue has increased by only about 22%.

This could indicate:

Inventory buildup
Lower turnover
Obsolescence risk
Supply-chain strategy changes
Demand weakness

The buyer should determine whether the higher inventory balance represents a normal operating requirement or a temporary problem that should be adjusted.

Accounts Payable Trends

Accounts payable can materially affect closing working capital.

A seller may temporarily improve cash balances by delaying supplier payments before closing.

This practice can increase accounts payable and reduce net working capital.

Illustrative Example

Historical accounts payable:

$6 million

Accounts payable immediately before closing:

$9 million

If the increase reflects delayed vendor payments rather than normal operations, the buyer may challenge the closing working capital calculation.

Analyzing Days Payable Outstanding and supplier aging can help determine whether the balance is unusual.

Working Capital Manipulation Before Closing

Because the working capital adjustment affects seller proceeds, both parties should consider whether unusual actions have been taken before closing.

Potential examples include:

Aggressively collecting receivables
Delaying vendor payments
Reducing inventory purchases
Accelerating billing
Deferring ordinary operating expenses

The purchase agreement may contain covenants requiring the seller to operate the business in the ordinary course before closing.

These protections help reduce the risk that working capital is artificially manipulated to increase seller proceeds.

What Is a Working Capital Collar?

Some transactions use a working capital collar to prevent small fluctuations from creating unnecessary purchase price adjustments.

For example:

Peg: $10 million
Lower Collar: $9.5 million
Upper Collar: $10.5 million

If closing working capital falls between $9.5 million and $10.5 million, no adjustment may occur.

If closing working capital falls outside the range, an adjustment may apply according to the purchase agreement.

Collars can reduce disputes over immaterial differences.

Working Capital Collar Example

Closing NWC	Potential Treatment
$9.7M	No Adjustment
$10.2M	No Adjustment
$9.0M	Downward Adjustment
$11.0M	Upward Adjustment

Working Capital Thresholds and Baskets

Other transaction structures may use thresholds or baskets rather than a traditional collar.

For example, the purchase agreement might state that no adjustment is made unless the difference exceeds $250,000.

The exact structure depends on negotiation and the size and volatility of the business.

Estimated Closing Working Capital vs. Final Closing Working Capital

Many transactions use a two-stage adjustment process.

Stage 1: Estimated Closing Statement

Shortly before closing, the seller prepares an estimate of:

Closing cash
Debt
Working capital
Other purchase price adjustments

This estimate is used to determine the amount paid at closing.

Stage 2: Final Closing Statement

After closing, the buyer may prepare a final calculation using actual closing balances.

The difference between the estimated and final amounts results in a post-closing true-up.

Post-Closing Working Capital True-Up Example

Assume:

Working Capital Peg: $12M
Estimated Closing NWC: $11.5M
Final Closing NWC: $10.8M

At closing, the preliminary adjustment is:

$11.5M − $12M = ($0.5M)

After finalization:

$10.8M − $12M = ($1.2M)

The additional post-closing adjustment is therefore:

($1.2M) − ($0.5M) = ($0.7M)

Item	Amount
Initial Closing Adjustment	($0.5M)
Final Required Adjustment	($1.2M)
Additional Post-Closing True-Up	($0.7M)

How Working Capital Disputes Arise

Post-closing working capital disputes commonly arise because buyers and sellers interpret accounting rules or transaction definitions differently.

Common disputes include:

Receivable reserves
Inventory reserves
Deferred revenue
Accrued bonuses
Unrecorded liabilities
Transaction expenses
Accounting cut-off
Changes in accounting policies

Many disputes are not about arithmetic.

They are about classification and accounting methodology.

The Importance of the Purchase Agreement Accounting Hierarchy

A well-drafted purchase agreement often specifies the accounting principles that should be used to calculate closing working capital.

An illustrative hierarchy may prioritize:

Specific accounting principles stated in the purchase agreement
Historical accounting policies consistently applied
Applicable accounting standards

This hierarchy can reduce the risk that one party changes accounting policies after signing to influence the final adjustment.

Buyer Strategy for Working Capital Negotiations

Buyers should generally:

Analyze at least 12–24 months of monthly working capital data.
Identify seasonal patterns.
Normalize unusual balances.
Evaluate recent growth.
Review customer and supplier terms.
Analyze receivable and payable aging.
Identify debt-like items separately.
Document accounting methodologies clearly.

These steps are naturally connected with the broader financial due diligence process.

Seller Strategy for Working Capital Negotiations

Sellers should generally prepare their own working capital analysis before entering detailed negotiations.

This may include:

Historical monthly balances
Seasonality schedules
Working capital as a percentage of revenue
Explanation of unusual balances
Accounting policy documentation
Proposed account definitions

A seller that waits until the buyer presents a proposed peg may lose negotiating leverage.

Working Capital Peg and Quality of Earnings

Working capital findings can also provide important insight into the quality of earnings.

Examples include:

Rising receivables may indicate weaker cash collection.
Growing inventory may indicate demand weakness.
Increasing payables may indicate cash pressure.
Deferred expenses may temporarily increase EBITDA.

These issues can affect both normalized EBITDA and the amount of working capital required at closing.

For a broader understanding of transaction-focused earnings analysis, see What Buyers Examine During Financial Due Diligence: A Complete Guide.

Key Takeaway

Seasonality, growth, receivable collection, inventory management, supplier payment patterns, and accounting policies can all materially affect the appropriate working capital peg.

A simple historical average is therefore not always sufficient.

Buyers and sellers should analyze the underlying operating cycle and expected conditions at closing, while ensuring that the peg and final closing calculation are based on consistent accounting principles.

Post-closing true-ups, collars, thresholds, and dispute-resolution mechanisms can further affect the ultimate purchase price.

Because these mechanics can move transaction proceeds by millions of dollars, working capital analysis should be integrated with financial due diligence, Quality of Earnings analysis, and the broader M&A purchase price framework.

Working Capital Peg Negotiation: Buyer vs. Seller Positions

The working capital peg is often one of the most heavily negotiated components of an M&A purchase price mechanism.

The reason is simple: every dollar added to or removed from the agreed target can potentially affect the amount ultimately paid to the seller.

Although both parties may analyze the same historical balance sheet data, buyers and sellers often reach different conclusions because they have different economic incentives.

Buyer Position

A buyer generally wants the business to be delivered with enough operating working capital to continue normal operations immediately after closing.

The buyer may therefore argue for a higher peg when:

Recent working capital requirements have increased.
The company is growing rapidly.
Receivable collection periods have lengthened.
Inventory requirements have increased.
Supplier payment terms have become less favorable.
The expected closing date falls within a seasonal peak.

Seller Position

A seller generally wants to avoid transferring more working capital than the business reasonably requires.

The seller may therefore argue for a lower peg when:

Recent balances contain temporary or unusual increases.
Historical averages better represent normal operations.
Inventory includes excess or non-recurring purchases.
Receivables contain temporary timing differences.
Current working capital has been affected by transaction-related events.

Illustrative Buyer vs. Seller Peg Negotiation

Assume the following historical data:

Measure	Amount
12-Month Average NWC	$10.0M
6-Month Average NWC	$11.2M
3-Month Average NWC	$12.0M
Latest Month NWC	$12.4M

The seller may argue that the normalized peg should be:

$10.0 million

based on the trailing twelve-month average.

The buyer may argue that:

$12.0 million

better reflects the company’s current operating scale.

The $2 million difference can become a direct purchase price negotiation item.

How the Peg Affects the Purchase Price Bridge

Working capital is generally one component of the broader bridge from Enterprise Value to Equity Value.

A simplified transaction bridge may look like this:

Transaction Item	Amount
Enterprise Value	$200M
Add: Cash	$8M
Less: Debt	($35M)
Less: Debt-Like Items	($4M)
Working Capital Adjustment	($3M)
Indicative Equity Value	$166M

This demonstrates why headline Enterprise Value alone does not determine the final consideration paid to shareholders.

Working capital, cash, debt, and debt-like obligations all influence the final transaction proceeds.

Working Capital Peg and Enterprise Value

The working capital peg generally does not change Enterprise Value itself.

Instead, it determines whether the actual working capital delivered at closing is consistent with the operating assumptions embedded in the negotiated Enterprise Value.

This distinction is important when analyzing how debt and cash affect transaction value and how Enterprise Value ultimately converts into Equity Value.

How Sellers Can Prepare Before a Transaction

Sellers should not wait until late-stage purchase agreement negotiations to analyze working capital.

A well-prepared seller may complete a working capital study before launching the sale process.

This analysis may include:

24–36 months of monthly working capital balances
Revenue trends
Seasonality
DSO, DIO, and DPO trends
Account-level classifications
Unusual historical balances
Debt-like item identification
Proposed normalized peg

This preparation can help management defend its position during buyer diligence.

How Buyers Should Analyze the Working Capital Peg

A buyer should independently evaluate the seller’s proposed target rather than accepting it automatically.

The review may include:

Monthly trial balance data
Accounts receivable aging
Inventory aging
Accounts payable aging
Historical payment practices
Working capital as a percentage of revenue
Seasonal patterns
Recent growth
Accounting policy consistency

This work is commonly performed alongside financial due diligence.

How Quality of Earnings Findings Can Change the Peg

Quality of Earnings analysis can reveal trends that materially influence working capital normalization.

For example:

Revenue Adjustment

If reported revenue includes significant one-time sales, historical receivables associated with those sales may not represent future working capital requirements.

Customer Concentration

If a large customer has unusually long payment terms, the buyer may need to evaluate whether those terms will continue after closing.

Expense Normalization

Under-accrued payroll or supplier expenses can indicate that closing working capital liabilities are understated.

Cash Conversion

Weak cash conversion may indicate that the business requires more working capital than headline EBITDA suggests.

These issues reinforce the connection between working capital analysis and the broader Quality of Earnings analysis.

Common Working Capital Peg Disputes

Working capital disputes commonly arise after closing when the parties interpret definitions or accounting methodologies differently.

1. Accounts Receivable Reserves

The buyer may increase bad debt reserves after closing, reducing net working capital.

The seller may argue that the reserve methodology differs from historical accounting practices.

2. Inventory Reserves

The buyer may write down slow-moving or obsolete inventory.

The seller may argue that the closing calculation should use the same reserve methodology used when establishing the peg.

3. Accrued Bonuses

Disputes may arise over whether bonuses should be treated as working capital, debt-like items, or seller expenses.

4. Deferred Revenue

Buyers and sellers may disagree over whether deferred revenue should be included at gross carrying value or adjusted for future fulfillment costs.

5. Transaction Expenses

Unpaid legal, accounting, advisory, or investment banking fees may be disputed if the purchase agreement does not clearly classify them.

Example of a Working Capital Dispute

Assume the agreed peg is:

$15 million

The seller calculates closing working capital at:

$14.5 million

The buyer calculates:

$12.8 million

The difference is:

$1.7 million

The disagreement may arise from:

Disputed Item	Amount
Additional AR Reserve	$0.6M
Inventory Reserve	$0.4M
Bonus Accrual	$0.3M
Unrecorded Vendor Liabilities	$0.4M
Total Difference	$1.7M

This illustrates why the accounting definitions in the purchase agreement can be as important as the negotiated target itself.

How Purchase Agreements Reduce Working Capital Disputes

A well-drafted agreement should clearly define:

Net Working Capital
Included accounts
Excluded accounts
Accounting principles
Calculation methodology
Closing statement procedures
Review periods
Dispute resolution procedures

Where appropriate, transaction documents may include an illustrative working capital schedule showing exactly how the calculation should be performed.

The Importance of an Illustrative Closing Statement

An illustrative closing statement can significantly reduce ambiguity.

For example:

Account	Treatment
Accounts Receivable	Included
Inventory	Included
Prepaid Operating Expenses	Included
Accounts Payable	Included
Accrued Payroll	Included
Cash	Excluded
Bank Debt	Excluded
Transaction Expenses	Debt-Like / Separate Adjustment

This can help both parties understand the agreed methodology before closing.

Role of an Independent Accountant in Working Capital Disputes

Many purchase agreements provide for an independent accounting firm to resolve unresolved post-closing working capital disputes.

The independent accountant may be asked to determine:

Whether an account is properly included
Whether accounting principles were applied consistently
Whether reserves were appropriate
Whether the closing statement follows the purchase agreement

The scope of the accountant’s authority should be clearly defined in the transaction documents.

Working Capital Peg and Earnouts

Working capital adjustments and earnouts are separate mechanisms, but they can interact.

For example, if the post-closing business starts with insufficient working capital, this may affect future performance and potentially make an earnout target more difficult to achieve.

Where significant contingent consideration is involved, transaction parties should consider whether working capital at closing could affect future performance metrics.

For more detail on contingent consideration structures, see Understanding Earnouts in M&A Transactions: A Complete Guide.

Working Capital Peg and Private Equity Transactions

Working capital analysis is particularly important in private equity acquisitions because the transaction is often highly sensitive to cash generation and leverage.

A lower-than-expected level of working capital can require an immediate equity contribution after closing.

This may affect:

Initial sponsor equity
Debt repayment capacity
Free cash flow
IRR
MOIC

For this reason, private equity firms commonly incorporate final working capital findings into their acquisition models and Investment Committee analysis.

For a broader view of the underwriting process, see How Private Equity Firms Evaluate Investment Opportunities: A Complete Guide.

Working Capital Peg and the Investment Committee

For significant acquisitions, Investment Committees may review:

Proposed working capital peg
Historical working capital trends
Seasonality
Potential purchase price adjustments
Disputed classifications
Cash requirements immediately after closing

A material difference between the initial model and final working capital requirement can affect the amount of equity required and the expected investment return.

This information may therefore be summarized in the Investment Committee Memorandum.

Red Flags Buyers Should Watch For

Potential working capital warning signs include:

Receivables increasing faster than revenue
Growing aged receivables
Large inventory buildup
Increasing obsolete inventory
Supplier payments being delayed
Unusual pre-closing collections
Under-accrued operating expenses
Frequent changes in accounting classifications
Large unexplained month-end adjustments

These issues may indicate that reported working capital does not reflect normal operating conditions.

Red Flags Sellers Should Watch For

Sellers should also be alert to buyer adjustments that may artificially increase the working capital shortfall.

Potential issues include:

Introducing new reserve methodologies after closing
Changing historical accounting policies
Including liabilities excluded from the peg calculation
Double counting debt-like items
Using hindsight unavailable at closing
Reclassifying normal accounts after the transaction

A clearly drafted purchase agreement and well-supported historical analysis can help reduce these risks.

Working Capital Peg Negotiation Checklist

Before agreeing to a working capital target, buyers and sellers should review:

Monthly working capital history
Seasonality
Revenue growth
Accounts receivable aging
Inventory aging
Accounts payable aging
Customer and supplier payment terms
Accounting policy consistency
Debt-like item classifications
Transaction expenses
Deferred revenue
Accrued bonuses
Expected closing date
Illustrative closing statement
Post-closing true-up procedure

Key Takeaway

The working capital peg can materially affect seller proceeds and buyer funding requirements even when the negotiated Enterprise Value remains unchanged.

Successful working capital negotiations require more than calculating a historical average. Buyers and sellers should understand seasonality, growth, account classifications, accounting methodologies, debt-like items, and closing mechanics.

Clear definitions and consistent accounting policies are particularly important because many post-closing disputes arise from classification and methodology rather than simple arithmetic.

Working capital should therefore be analyzed together with financial due diligence, Quality of Earnings analysis, and the broader purchase price bridge to ensure that transaction economics are properly understood.