Insights

The working capital peg: where sellers lose money after the handshake

You agreed on a price. The letter of intent says $8 million, you shook hands, and you started picturing the wire hitting your account. Then, weeks into diligence, the buyer's team starts talking about a "working capital peg," and suddenly the number at closing is not $8 million anymore. Nothing shady happened. You just met the part of the deal nobody explained, and it moves real money in almost every sale.

What a working capital peg actually is

Most lower middle market deals are priced "cash-free, debt-free." The buyer keeps neither your cash nor your debt; you sweep the bank accounts and pay off the loans at closing. But the business still needs fuel in the tank to run on day one: receivables that will turn into cash, inventory on the shelves, minus the payables and accruals that come due. That fuel is net working capital.

The peg, sometimes called the working capital target, is the amount of net working capital you agree to deliver with the business at closing. Deliver more than the peg and the price adjusts up. Deliver less and it adjusts down, dollar for dollar. It is not a penalty and it is not negotiable in spirit, because no buyer will fund the company's operations twice, once in the purchase price and again the week after closing.

The principle is fair. The number is where the fight is.

How the peg gets set, and why the method matters more than the number

The standard approach is an average of the company's net working capital over the trailing twelve months. Sounds mechanical. It is not, because three judgment calls sit inside it:

What counts. Does "net working capital" include the current portion of deferred revenue? Customer deposits? That shop truck you expensed? Every line item included or excluded moves the peg, and the buyer's accountants will have opinions about all of them.

Which periods. A twelve-month average treats a seasonal business unfairly in both directions. A construction or CPG company closing in its heavy season carries far more receivables and inventory than its annual average, which means the seller hands over extra value for free unless the peg accounts for seasonality.

Whose accounting. If your books are cash basis, or your inventory counts are loose, or revenue gets recognized whenever the invoice goes out, the buyer will restate everything to an accrual view during their quality of earnings work. The peg then gets set off their numbers, not yours.

Here is the part that costs sellers the most: the LOI usually says something brief like "the purchase price assumes a normalized level of working capital, to be determined during diligence." You signed exclusivity on the price. The peg gets decided later, when you have no competing buyers and no leverage. That single vague sentence is one of the most expensive sentences in M&A.

Where sellers get hurt

The damage usually comes from a handful of repeat offenders. The owner who tightens collections hard in the months before closing feels smart, but pulling cash out of receivables shrinks working capital, drops you below the peg, and gives the money right back at the true-up. The seasonal business pegged at a flat annual average donates its peak-season inventory. The company with stale inventory or doubtful receivables watches the buyer carve them out of the calculation entirely, lowering delivered working capital after the peg was already set. And almost every deal has a post-closing true-up, a recalculation 60 to 120 days after closing, which means the final price is not final on closing day and disputes get resolved when the buyer already owns the company.

How to set the peg on your terms

The good news: this is one of the most controllable parts of a deal, if you start before the LOI instead of after.

• Put the methodology in the LOI, not just the concept. Which accounts are included, which months are averaged, how seasonality is handled, and who prepares the calculation. Specific beats vague, every time.
• Get to clean accrual-basis monthly balance sheets at least a year out. If the buyer's accountants build the working capital history, the peg will be built to favor them.
• Run the business normally through closing. No collection blitzes, no stretching payables, no inventory drawdowns. Gaming working capital in your favor before close almost always reverses at the true-up.
• Model the adjustment before you sign anything. A good advisor will show you the expected peg and the likely true-up range next to the headline price, so you compare offers on what actually hits your account.
• Negotiate a collar if the swings are big. A band around the peg where no adjustment applies keeps small noise from turning into post-closing arguments.

This is exactly the kind of mechanism a real sell-side process manages for you, and it is a core part of what a Texas business broker actually does beyond finding the buyer.

The bottom line

The working capital peg does not show up in the headline number, which is why owners ignore it until it costs them. Two offers at the same price can differ by hundreds of thousands of dollars once the peg and the true-up play out. Treat working capital as part of the price, negotiate it while you still have competition, and keep your balance sheet clean enough that the calculation runs off your numbers.

If you are thinking about a sale in the next year or two, the Insights library covers the rest of the process, or book a confidential call and I will walk you through how a peg would likely be set for your business.

This article is general information, not legal, tax, or financial advice. Working capital definitions and adjustments are deal-specific contract terms. Involve your attorney and CPA before signing an LOI or purchase agreement.

Frequently asked questions

What is a working capital peg when selling a business?

A working capital peg is the target amount of net working capital, typically receivables plus inventory minus payables and accruals, that a seller agrees to deliver with the business at closing. If actual working capital at closing is above the peg, the purchase price adjusts up; if it is below, the price adjusts down dollar for dollar. It exists because the buyer is paying for an operating business, which needs working capital to run from day one.

How is the working capital peg calculated?

Most deals set the peg as the average monthly net working capital over the trailing twelve months, adjusted for items the parties agree to exclude, such as cash, debt, stale inventory, or doubtful receivables. The details matter: which accounts are included, which months are averaged, and whether the calculation uses the seller's books or the buyer's restated accrual numbers can each move the peg significantly, especially for seasonal businesses.

Does the buyer get my cash and accounts receivable when I sell?

In a typical cash-free, debt-free deal the seller keeps the cash and pays off the debt at closing, but accounts receivable usually transfer with the business as part of working capital. That is why collecting receivables aggressively right before closing backfires: it converts working capital into cash you keep, drops delivered working capital below the peg, and triggers a price reduction of roughly the same amount.

What is a working capital true-up?

A true-up is the post-closing recalculation of actual working capital delivered, usually 60 to 120 days after the sale closes. Closing happens on an estimate; the true-up settles the difference in either direction. Sellers should negotiate the calculation method, dispute process, and any collar before signing, because by the time the true-up happens the buyer controls the books.