Working capital peg: how it is set and how sellers prepare

A working capital peg is the level of net working capital a seller agrees to deliver with the business at closing, and the purchase price moves up or down based on how much is actually delivered. It is usually set from an average of recent month-end balances, adjusted for seasonality and one-off items, and it is negotiated separately from the headline price.

Decipher's guide to quality of earnings and EBITDA adjustments covers how diligence tests earnings. This post covers the peg itself: what goes into it, how the true-up works, and what sellers can prepare.

Net working capital in a deal

In a deal, net working capital (NWC) usually means operating current assets minus operating current liabilities: receivables, inventory and prepaid expenses, less payables, accrued liabilities and, depending on the deal, deferred revenue.

Most deals are priced on a cash-free, debt-free basis: the seller keeps the cash and pays off the debt, so both are left out of NWC. What remains is the operating capital the business needs to run, which a buyer expects to come with it.

How the peg is set

The peg is meant to represent a normal level of NWC. The usual starting point is an average of month-end NWC over the trailing 12 months, which captures a full operating cycle.

That average is then adjusted:

• Seasonality. A business that bills heavily in one quarter carries more receivables in some months. A 12-month average smooths this; a shorter window at a seasonal high or low would not.
• One-off items. A large receivable from a project that will not repeat, a delayed vendor payment run, or a bonus accrual that was paid late all distort individual months and are often normalized out.
• Growth. In a fast-growing business, a buyer may argue a trailing average understates the NWC needed today.
• Definitions. Every account included or excluded changes the result, which is why the definitions are negotiated alongside the number.

The true-up at closing

At closing, the parties estimate NWC and adjust the price. After closing, usually within a period set in the purchase agreement, the buyer prepares a final closing statement and the price is trued up to the actual figure. A shortfall against the peg reduces the price dollar for dollar; an excess may increase it, depending on how the agreement is written.

Illustrative figures, not client data.

Delivered NWC is 250 below the peg, so a headline price of 12,000 becomes 11,750 before any separate adjustments for cash and debt. Nothing went wrong in the business; receivables were simply collected faster and payables and accruals ran higher on the closing date. Definitions and closing timing matter as much as the peg.

Items commonly negotiated

None of these are fixed rules. Each is a point that buyers and sellers commonly negotiate.

• Cash and debt. Typically excluded from NWC and handled separately in the cash-free, debt-free calculation.
• Deferred revenue. For subscription and software businesses, this is often the largest item. Including it in NWC lowers both the peg and the delivered figure. Some buyers instead treat it as a debt-like item and deduct it from the price, which can cost the seller more.
• Accrued liabilities. Accrued bonuses, payroll taxes and similar items may sit in NWC or be treated as debt-like. The same liability should not be counted in both.
• Collars. Some agreements include a band around the peg within which no adjustment is made.

How sellers prepare

The goal is to arrive with the seller's own analysis, built from the data the buyer will use.

1. Produce monthly balance sheets on an accrual basis. NWC is measured at month ends, so a monthly close with accruals recorded is the foundation. A disciplined close also supports a monthly budget vs actual review.
2. Build 12 to 24 months of NWC history. Calculate NWC for each month end using the definitions a buyer is likely to propose, and note what drove large swings.
3. Document the one-off items. If a month is unusual, write down why, with support, before anyone asks.
4. Decide the position on deferred revenue and accruals early. Model the peg under each treatment so the price impact is clear before the letter of intent.
5. Run the business normally into closing. Changes in collection or payment behavior before closing tend to show up in the monthly history. A 13-week cash flow forecast helps manage cash through the process without distorting working capital.

In Decipher's experience, the peg is often negotiated after the headline price, under time pressure. A seller who knows the monthly history negotiates from evidence, not from the buyer's first draft.