What the buyer thinks is settled: “We agreed on $5M. The number’s the number.”

What’s still wide open: how much working capital comes with the business at close. Get this wrong and you’ll wire an extra $200K at closing, or hand the seller a windfall, over a mechanism most first-time buyers didn’t know was in the purchase agreement. The working-capital peg (or “target”) is the most expensive clause that buyers routinely ignore.

Why the peg exists at all

Most middle-market deals are structured “cash-free, debt-free”: the seller keeps the cash and pays off the debt at close, and you buy the operating business. But an operating business needs working capital, receivables and inventory net of payables, to run on day one. If the seller drains the receivables and stops paying vendors right before close, you’d inherit a business that can’t make payroll Monday morning.

The peg prevents that. It sets a normal level of working capital that must be delivered with the business. At close, actual working capital is compared to the peg:

  • Actual above the peg → the buyer pays the seller the difference (you got extra working capital, you pay for it).
  • Actual below the peg → the seller pays the buyer the difference (you got shorted, you’re made whole).

The logic is fair. The number is where the money is.

Where first-timers lose it

1. Accepting the seller’s peg without testing it. The peg should be the business’s normal, average working capital, typically a trailing 12-month average to wash out seasonality. Sellers propose a peg set at the business’s low point. If the true average net working capital is $800K but the seller pegs it at $600K, then delivering a normal $800K at close triggers a $200K payment from you to the seller, on top of the price. You just paid $5.2M for a $5M deal and didn’t notice.

2. Ignoring seasonality. If working capital swings from $500K in the slow season to $1.1M at peak, when you close changes everything. Close at the seasonal peak against a low peg and the true-up bill is brutal. The peg and the closing date have to be negotiated together.

3. Not defining the components. Is that 120-day-old receivable a real asset or a write-off? Is slow-moving inventory counted at cost or hair-cut? Every dollar of definitional ambiguity is a dollar someone will claim at the true-up. The quality-of-earnings review should feed straight into the working-capital analysis, the same scrub that normalizes EBITDA normalizes working capital.

4. Forgetting it’s real cash at close. The peg true-up is funded in cash, at closing, on top of your equity and debt. If your capital stack is built to the dollar with no cushion, a working-capital true-up you didn’t model is exactly the kind of last-minute hole that forces a scramble, or a bridge, when the senior facility is already sized.

How to win it (or at least not lose it)

  • Compute the true trailing-12-month average net working capital yourself, from the target’s actual monthly balance sheets. Bring your number; don’t react to theirs.
  • Negotiate the peg and the closing date as one decision, accounting for seasonality.
  • Define every component in the agreement, aging cutoffs for receivables, valuation method for inventory, what’s included and excluded, so the post-close true-up is arithmetic, not a fight.
  • Budget a cash cushion for the true-up in your capital stack, because you won’t know the exact figure until close.

Why it matters to a lender

A senior lender lending against a business’s working capital cares intensely that the business arrives with adequate working capital. A sensible peg protects the lender too, which is why a buyer who has clearly analyzed and negotiated the peg looks more credible in credit committee than one who accepted the seller’s figure. It signals you understand what you’re actually buying.

Run your own file first

Understanding your own working-capital cycle is the first step to negotiating someone else’s. Run the assessment or send us your documents and we’ll show you how a credit team reads it.

Educational only. Nothing here is an offer of credit, a commitment to lend, accounting or legal advice, or advice on any specific transaction.