Working Capital Peg

M&A purchase prices are usually struck as an enterprise value on a cash-free, debt-free basis — the buyer is paying for the operating business, not the cash in the bank or the debt on the books, which get settled separately at close. But a business also needs working capital to operate: receivables to collect, inventory on the shelf, payables outstanding. Without a peg, a seller could strip working capital before closing — aggressively collecting receivables, delaying payments to vendors, running down inventory — and hand the buyer a hollowed-out business that needs an immediate cash injection. The peg locks in a 'normal' delivered level, usually set as the trailing 12-month average net working capital to smooth out seasonality.

At signing, the parties agree on the peg. Around closing, the buyer (or seller) prepares an estimated closing balance sheet and the purchase price is preliminarily adjusted. Within 60–120 days post-close, a final closing-date working capital figure is calculated and compared to the peg. If actual NWC exceeds the peg, the buyer pays the seller the excess (the seller delivered more current assets than promised). If actual NWC falls short, the seller refunds the buyer the shortfall. Disputes over the final number are common and usually resolved by an independent accounting arbitrator named in the purchase agreement. Definitions matter enormously — what's in current assets/liabilities, treatment of accrued bonuses, deferred revenue, and the like are all negotiated.

The peg level is a real negotiation, often using a trailing-twelve-month average so neither side games a single seasonal date. Buyers want a HIGHER peg (forcing the seller to deliver more working capital, or pay a shortfall); sellers want a LOWER peg (so they can keep more of the cash generated and avoid a refund). The accounting policies used to compute working capital must be consistent and pinned down ('in accordance with GAAP applied on a basis consistent with past practice'), because a difference in how, say, deferred revenue or warranty reserves are treated can swing the figure by millions. Highly seasonal businesses are the hardest to peg and often use month-end averages.