Working Capital Peg Explained: How It Affects Your Business Sale Price

You've agreed on a purchase price. The LOI is signed. You think the hard part is over. Then your buyer's attorney introduces something called a "working capital peg," and suddenly you're negotiating all over again.

Working capital pegs are one of the most misunderstood — and most consequential — elements of a business sale. They can add tens or hundreds of thousands of dollars to your final payout, or they can quietly erode it. Here's what every seller needs to know.

What Is a Working Capital Peg?

A working capital peg (sometimes called a net working capital target) is a dollar amount that represents the "normal" level of working capital the business needs to operate. It's baked into the purchase agreement, and the buyer expects to receive the business with at least that much working capital on the balance sheet at closing.

Working capital, in simple terms, is current assets minus current liabilities. It includes things like cash in the operating account, accounts receivable, inventory, prepaid expenses, accounts payable, and accrued liabilities.

The peg itself is typically set as the trailing 12-month average of net working capital, though the exact lookback period is negotiable.

If you deliver more working capital than the peg at closing, the buyer owes you the difference. If you deliver less, the purchase price is reduced. This is known as the purchase price adjustment.

How Is the Net Working Capital Target Calculated?

The calculation starts with a quality of earnings (QoE) analysis, usually performed by the buyer's accountants. They'll review your monthly balance sheets and calculate net working capital for each month over the trailing 12 months (sometimes 24 months).

Here's a simplified example:

• Average current assets (12 months): $420,000
• Average current liabilities (12 months): $180,000
• Net working capital target: $240,000

The buyer will then expect $240,000 of net working capital in the business at closing. This isn't extra money on top of the purchase price — it's what's considered "already included" in the deal.

What's typically included:

• Accounts receivable
• Inventory
• Prepaid expenses
• Accounts payable
• Accrued wages and taxes
• Customer deposits

What's typically excluded:

• Cash and cash equivalents (seller keeps these)
• Long-term debt (buyer assumes or it's paid off)
• Income tax liabilities
• Related-party receivables or payables

Not every deal defines these the same way, and the specific inclusions and exclusions can significantly shift the peg number. This is where experienced advisors earn their fee. For a deeper understanding of how these financial metrics affect your sale, check out our EBITDA calculator and business valuation calculator.

The True-Up Mechanism

Most deals don't settle the working capital question at closing. Instead, they use a true-up mechanism that works like this:

1. Estimated working capital is calculated a few days before closing based on the most recent financials.
2. The deal closes using that estimate.
3. Within 60-90 days after closing, the buyer's accountants prepare a final working capital calculation based on the actual closing-date balance sheet.
4. The difference between the estimate and the final number is settled — either the buyer pays the seller or the seller refunds the buyer.

This post-closing adjustment is almost always a source of tension. The buyer now controls the books and has every incentive to classify items in ways that lower the final working capital number. Sellers need to negotiate strong dispute resolution provisions in the purchase agreement.

Common Working Capital Disputes

Working capital disputes happen in a significant percentage of deals. The most common fights include:

• Inventory valuation — The buyer writes down "obsolete" inventory after closing
• Receivables collectability — The buyer reserves against receivables they deem uncollectible
• Accrual timing — Expenses that should have been accrued before closing are pushed to the pre-closing period
• Definition disagreements — Items that weren't clearly included or excluded become contested
• Seasonal adjustments — The trailing average doesn't reflect the business's position at the time of closing

Many purchase agreements include an independent accountant resolution process where a neutral third party (usually a Big Four or regional firm) resolves disputes. The cost is typically split between buyer and seller.

Negotiation Tips for Sellers

Working capital negotiations can feel like an afterthought during the excitement of a deal, but they deserve serious attention. Here's how to protect yourself:

1. Understand your own numbers first. Before you even go to market, calculate your trailing 12-month net working capital. Know what's normal. Our SDE calculator can help you understand how discretionary earnings relate to your overall financial picture.

2. Negotiate the definition early. Don't wait until the purchase agreement to define what's in and what's out. Get alignment during the LOI stage.

3. Watch for seasonal distortion. If your business is seasonal, a simple 12-month average might not reflect your closing-date reality. Consider negotiating a seasonal adjustment or a lookback period that accounts for cyclicality.

4. Push for a collar or threshold. A "collar" means no adjustment is made unless the difference exceeds a certain dollar amount (e.g., +/- $25,000). This prevents minor fluctuations from triggering payments.

5. Retain audit rights. Make sure you have the right to review and dispute the buyer's post-closing working capital calculation. Insist on access to the books for the true-up period.

6. Don't manipulate the numbers. Some sellers try to inflate working capital before closing by delaying payments or accelerating collections. Buyers and their accountants will catch this, and it will damage trust — or worse, trigger indemnification claims.

How Working Capital Affects Your Total Proceeds

Think of it this way: the purchase price in the LOI is almost never the exact amount you walk away with. The working capital adjustment is one of several mechanisms that can move the final number up or down.

If you've been running a lean operation with minimal working capital, the peg might work in your favor — the target could be set low, and any surplus at closing means extra cash to you. If you've been carrying heavy inventory or extending generous payment terms, the peg could be set high, and you may owe money back after closing.

The key is to understand these dynamics before you sign the LOI, not after. If you're thinking about selling, start by getting a clear picture of your business's value with our free valuation assessment and reading our comprehensive guide to selling your business.

Working capital pegs aren't glamorous, but they're one of the levers that determine whether your deal closes at the price you expected — or somewhere disappointingly below it.