Quick Answers: Working Capital Pegs in M&A

What is a working capital peg?
A working capital peg is the agreed-upon amount of working capital a seller must leave in the business at closing so the company can continue operating normally after the transaction.

Why does working capital matter in a business sale?
If the business delivers less working capital than the agreed target, the purchase price is typically reduced. If it delivers more, the seller may receive additional compensation, depending on the purchase agreement.

How is working capital calculated?
Working capital generally consists of current operating assets, such as accounts receivable and inventory, less current operating liabilities like accounts payable and accrued expenses.

Can the working capital peg be negotiated?
Yes. The peg is one of the many terms negotiated during the transaction and should reflect the normal operating needs of the business rather than an arbitrary target.

The Hidden Variable: Why the Working Capital Peg Can Change Your Final Payout

Many business owners assume that once they sign a Letter of Intent, the purchase price is largely settled.

In reality, several important financial terms are still being negotiated. One of the most significant, and least understood, is the working capital peg.

For owners who have never sold a business before, this concept often comes as a surprise. Yet it can meaningfully influence how much money actually reaches the seller at closing.

Understanding it early helps prevent confusion later.

Why Buyers Care About Working Capital

When a buyer acquires a business, they expect it to continue operating on day one.

Employees still need to be paid. Vendors expect payment. Inventory must be available. Customers continue placing orders.

Working capital provides the liquidity that keeps those daily operations moving.

Rather than purchasing a business that immediately requires additional cash to function, buyers expect the company to be delivered with a normal level of operating capital already in place.

That expectation is both reasonable and standard throughout the M&A market.

Where Negotiations Begin

The challenge is rarely the formula itself.

Most transactions calculate working capital using operating current assets, such as accounts receivable and inventory, less operating current liabilities, including accounts payable and accrued expenses.

The discussion usually centers on what constitutes normal working capital.

For a seasonal business, normal may look very different in July than it does in January.

For a rapidly growing company, historical averages may not accurately reflect today’s operating requirements.

These are judgment calls, and they deserve careful analysis before negotiations begin.

How Adjustments Affect Net Proceeds

Once a working capital target has been established, the business is measured against that target at closing.

If actual working capital falls below the agreed amount, the purchase price is generally adjusted downward because the buyer will need to contribute additional operating capital after closing.

If working capital exceeds the agreed target, the adjustment may benefit the seller depending on how the purchase agreement is structured.

This is why owners should evaluate more than the headline purchase price.

The structure of the transaction often determines the amount ultimately received.

Preparing Before Diligence Begins

One of the best ways to avoid surprises is to analyze working capital long before exclusivity begins.

At Lion Business Advisors, we review historical financial performance to understand how the business naturally operates throughout the year. We evaluate seasonal fluctuations, receivable collections, inventory levels, vendor payment cycles, and other operating trends that influence normal working capital.

We also use modern analytical tools, including Agentic AI, to identify historical patterns across multiple reporting periods. Technology allows us to model different scenarios and highlight potential areas of discussion before buyers begin their own financial review.

That preparation allows owners to enter negotiations with supporting data rather than relying on assumptions after diligence is already underway.

Why This Matters for Professional Advisors

Working capital adjustments often become one of the most technical discussions in a transaction.

For CPAs, attorneys, and wealth advisors, establishing a defensible working capital methodology early helps reduce disputes later in the process. It also gives the seller greater confidence that the agreed purchase price reflects the economics of the business rather than unexpected closing adjustments.

Like every other aspect of a transaction, preparation creates options.

The Practical Takeaway

The purchase price in an LOI is only one part of the financial picture.

Working capital, tax structure, debt payoff, and other closing adjustments all influence what the seller ultimately receives.

That is why experienced sell-side advisors focus on the entire transaction rather than a single number.

At Lion Business Advisors, we believe owners should understand how every component of a deal affects their outcome before negotiations begin. The more prepared you are before diligence starts, the fewer surprises you will encounter at the closing table.