A working capital peg is a negotiated “target” level of net working capital that the business is expected to deliver at closing. If actual closing working capital is above or below the peg, the purchase price is adjusted up or down.
Related: Earn-outs (contingent consideration) can overlap with working capital definitions and other post-close economics.
Key takeaways
- Working capital adjustments are about delivering a “normal” level of cash tied up in operations—so the buyer doesn’t fund a working capital shortfall on Day 1.
- Most fights are definition fights: which accounts are included, what accounting policies apply, and how estimates/accruals are treated.
- Decide early: locked-box vs closing accounts. The peg/adjustment mechanics are very different.
Step 1: Define net working capital (NWC)
At a basic level:
- NWC = Current assets (operating) − Current liabilities (operating)
- Typically exclude cash, debt, and debt-like items (depending on the deal’s “cash-free, debt-free” concept).
Common included accounts: A/R, inventory, prepaid expenses, A/P, accrued liabilities, deferred revenue (sometimes), operating tax balances (sometimes).
Step 2: Set the peg (the target)
The peg is usually based on a historical average (e.g., trailing 12 months) adjusted for seasonality, growth, and known changes. The goal is to match what the business needs to operate “normally” post-close.
Step 3: Prepare the closing statement (closing accounts)
On (or shortly after) closing, one side prepares a closing balance sheet that calculates actual NWC using the agreement’s definitions. The other side reviews and can dispute.
Critical drafting points
- Accounting basis: GAAP/IFRS? consistent with past practice? specific policies override?
- Estimates: inventory obsolescence, bonus accruals, warranty reserves, bad debt reserves.
- Cut-off: what is included as of 11:59pm on closing date? treatment of in-transit inventory/shipping terms.
- Deferred revenue: is it debt-like, working capital, or excluded? (Huge driver in SaaS.)
- Transaction expenses: excluded vs accrued (and whether they’re debt-like).
Step 4: Calculate the purchase price adjustment
Typical formula:
- If Actual NWC > Peg → buyer pays extra (increase purchase price).
- If Actual NWC < Peg → buyer pays less / seller refunds (decrease purchase price).
Worked example (simple)
Assume the deal is cash-free, debt-free with a working capital peg of $2.0M.
- Actual closing NWC = $1.6M
- Shortfall vs peg = $0.4M
- Purchase price decreases by $0.4M (subject to the agreement’s mechanics)
Locked-box vs closing accounts (why it matters)
- Locked-box: price is set using a historical balance sheet date; buyer gets economic benefit from that date; leakage protections matter.
- Closing accounts: price is adjusted after closing based on actual closing balance sheet; the peg and definitions are central.
Dispute patterns (what usually goes wrong)
- Revenue cut-off / unbilled revenue / returns reserves.
- Inventory valuation and write-downs.
- Accrued payroll/bonuses and vacation liabilities.
- Classification (operating vs debt-like).
- Changes in accounting policies post-close.
