Working capital peg

What it is

Most private company sales are priced on a cash-free, debt-free basis: the seller keeps surplus cash and repays debt, and the buyer pays for the business as a working operation.¹ A working operation needs working capital — stock on the shelves, invoices waiting to be paid, suppliers waiting to be paid in turn. The peg is the level of working capital both sides agree is normal for the business.

Working capital is usually defined as:

The exact definition is written into the sale agreement, line by line. Two businesses with identical accounts can have different pegs because the agreement treats an item — deferred revenue, say — differently.

How the adjustment works

Under a completion accounts mechanism, the buyer prepares accounts at the completion date and compares working capital with the target set in the agreement. If it comes in below the target, the seller refunds the shortfall; if above, the buyer pays the excess.² Every pound counts once, in either direction.

In a locked-box deal there is no true-up after closing: the price is fixed from an earlier balance sheet, so working capital is priced in at that date instead.¹

How the peg is set — and who it favours

The negotiation is almost never about the arithmetic. It is about which months go into the average and what is excluded.

• Trailing twelve-month average. The default. Fair for a stable business, but it can sit well below where working capital is at closing if the business is growing.
• Seasonal businesses. A peg set from a quiet month and a completion in a busy one (or the reverse) can swing the adjustment by more than any other line. The peg should reflect the month you expect to close in.
• Normalising items. One-off build-ups of stock, a customer who paid unusually late, a supplier stretched to flatter cash — each is argued in or out of the average.

Common mistakes

1. Leaving the definition to the end. The line-by-line definition decides the number. Agree it alongside the price, not in the last week of drafting.
2. Accepting a trailing average without checking the trend. Plot monthly working capital for two years before you agree any basis.
3. Managing working capital down before completion. Chasing receivables and stretching payables just before closing lowers working capital — and the adjustment hands the difference straight back to the buyer.
4. Forgetting it interacts with debt-like items. An item classified as debt-like cannot also sit in working capital. Check the two lists against each other.

See how the peg feeds into what you receive in the EV to equity bridge calculator, and how buyers analyse it in how to read a quality-of-earnings report.

Sources

1. RSM Australia, “Debt free, cash free transactions — the devil is in the detail” (January 2020). ↩ ↩²

2. Lander & Rogers, “M&A purchase price adjustment mechanisms — completion accounts vs locked box” (September 2023). ↩