Working Capital Peg

A working capital peg (also called a working capital target or working capital adjustment) is a provision in a business acquisition agreement that establishes a baseline level of net working capital the seller must deliver at closing. If the actual net working capital at closing exceeds or falls below the agreed-upon peg, the purchase price is adjusted dollar-for-dollar to compensate for the difference.

The peg is typically calculated as the trailing 12-month average of net working capital, defined as current assets minus current liabilities, excluding cash and funded debt. This mechanism ensures that the buyer receives a business with sufficient operational liquidity to continue normal operations without immediately injecting additional capital, while protecting the seller from having to leave excess working capital in the business beyond what is contractually required.

The working capital peg is one of the most negotiated provisions in any acquisition agreement, and for good reason. Without a clearly defined target, sellers have a financial incentive to aggressively collect accounts receivable, delay vendor payments, and draw down inventory in the weeks before closing. This effectively extracts cash from the business at the buyer's expense.

For buyers pursuing business acquisition financing, lenders scrutinize the working capital peg closely. A poorly negotiated peg can mean the buyer needs additional capital immediately after closing to fund day-to-day operations, undermining the financial model that justified the acquisition. SBA lenders in particular evaluate whether the agreed-upon working capital level supports the business's ability to service acquisition debt from day one.

For sellers, the peg determines how much operational cash they can extract before closing. Setting the peg too high forces the seller to leave more capital in the business than necessary; setting it too low invites post-closing disputes and purchase price clawbacks that can erode deal economics.

Using a single month's snapshot instead of a normalized average. Working capital fluctuates with seasonality, payment cycles, and one-time events. A single month's figure can dramatically overstate or understate the business's true working capital needs. The trailing 12-month average smooths these fluctuations, though businesses with strong seasonal patterns may require a more nuanced methodology.

Failing to define inclusions and exclusions precisely. The definition of "net working capital" varies by deal. Which current assets and current liabilities are included, how inventory is valued, whether prepaid expenses count, and how accrued liabilities are treated must all be explicitly defined in the purchase agreement. Ambiguity here is the single largest source of post-closing disputes.

Ignoring the true-up mechanism. Most deals include an estimated closing adjustment based on preliminary financials, followed by a true-up within 60 to 90 days once final closing-date financials are prepared. Buyers who do not budget for a potential true-up payment can face unexpected cash demands shortly after closing.

Not accounting for working capital needs in the financing structure. The peg affects how much additional working capital financing the buyer needs post-close. Failing to coordinate the peg negotiation with the lending team can result in an underfunded acquisition.