Working Capital Peg

A buyer agrees to pay for a business on the understanding that normal operating assets and liabilities remain in place. If the seller collects receivables but leaves bills unpaid just before closing, the buyer may inherit a cash need, so a working capital adjustment addresses defined changes.

The peg is a target, sometimes called a normalised working capital amount, which is compared with closing working capital calculated under the agreement, and the difference may alter the final price, although the exact mechanism is deal-specific. Kroll describes the adjustment as a way to protect both sides from fluctuations and support operations at close.

It notes that mechanisms may be two-way, one-way or capped, so do not assume the seller always gets full credit for an excess. Begin by defining working capital for the transaction, which often includes selected receivables, inventory and operating payables but may exclude cash, debt, tax balances or particular items, because the sale contract, not a textbook shorthand, controls the calculation.

A broad accounting definition can create surprises, since an overdue customer balance may be legally a receivable but difficult to collect and a slow-moving inventory item may need an allowance, so agree on consistent treatment before closing. Use a relevant historical period to consider normal operations: a twelve-month average may capture seasonality, but it may also contain one-off events or a business that has since grown, and adjustments should be explained and supported by data.

A peak month is not automatically fair and neither is the lowest month, so examine billing cycles, customer payment dates, supplier terms and inventory build, and consider what level the business truly needs at the expected closing date. For a simple two-way illustration, closing working capital of $2.6 million against a peg of $3 million produces a negative $0.4 million difference, and the price would fall by that amount if the contract specifies a dollar-for-dollar two-way adjustment without a cap or other rule.

Likewise, excess working capital may increase price under that same structure, but a one-way collar, threshold or excluded balance can change the result. Always read the signed purchase agreement before calculating settlement.

Distinguish estimated and final balances, since many deals use an estimated closing statement to set cash paid at completion followed by a true-up after the books close, and PwC describes post-closing adjustments as a process that can be disputed well after legal closing. Set the accounting hierarchy, because the parties might specify particular policies, then historical practice, then a financial reporting standard for unresolved items, and a vague reference to GAAP alone can leave a large argument over judgments.

Review cutoff at the closing time, as goods in transit, invoices raised after close for earlier work and payments released on the closing day can affect the balance, and agree who prepares the statement and what evidence each party may inspect. The peg should be considered with the headline value, because if one side negotiates a high target while keeping the same price it may shift value at closing, so a seller and buyer should model the full economics, not just the multiple.

Receivables and payables can be managed in the ordinary course, but changing collections or payment timing solely to change the closing adjustment can trigger disputes, and the agreement may contain ordinary-course covenants or specific protections. Not every acquisition uses completion accounts, since a locked-box price fixes value by reference to an earlier balance sheet with different protections, and calling a historical balance a 'peg' without an actual adjustment mechanism can confuse the deal.