Working Capital Peg in M&A: The Mechanism That Quietly Reduces Your Check by 5-15%

Working capital is the cash, receivables, and inventory the business needs to operate day-to-day. When you sell your business, the buyer expects you to leave enough working capital in the business at close so it can keep running. The amount you have to leave is called the “peg” or “target.”

If your actual working capital at close is below the peg, your check at close shrinks dollar-for-dollar. If it’s above, you get the surplus back.

Most owners ignore the working capital peg in their LOI. It’s a technical accounting topic buried among more glamorous terms like price and earnouts. That’s why it’s the buyer’s favorite place to recover money — sellers don’t fight it because they don’t understand it.

Wrong working capital methodology can cost the seller 5-15% of the headline price. On a $5M deal, that’s $250k-$750k of value transferred quietly between LOI and close. The fight isn’t over the actual working capital number on close day — it’s over how the “peg” (target) gets calculated.

This guide is for owners about to sign — or already negotiating — an LOI with a working capital adjustment clause. We’ll walk through what working capital actually is in M&A, how the three common methodologies bias the result, what to include and exclude, and the six specific provisions that determine whether you keep the headline price or quietly hand 10% back.

“The working capital peg is where buyers quietly recover 5-10% of the headline price they offered. Sellers who don’t fight it leave that money behind.”

Key Takeaways

• Working capital is the cash, receivables, and inventory needed to operate the business day-to-day. The peg is the target you must leave behind.
• Below-peg actual working capital reduces the seller’s check dollar-for-dollar; above-peg surplus is returned (usually).
• The fight is over METHODOLOGY, not the number. Trailing 12-month average favors sellers; buyer-chosen methodology favors buyers.
• Six provisions to negotiate at LOI: calculation methodology, exclusion list, measurement date, true-up timing, dispute resolution, cap on adjustment.
• Wrong working capital terms can transfer 5-15% of headline price from seller to buyer post-close.

What Working Capital Actually Is in M&A

Working capital is the short-term assets minus short-term liabilities the business needs to operate. In accounting terms: current assets (cash, receivables, inventory, prepaid expenses) minus current liabilities (accounts payable, accrued expenses, customer deposits). In M&A, the definition is custom-tailored in each deal — what counts and what doesn’t is negotiated, not assumed.

The buyer wants enough working capital to keep the business running through the transition. Without it, they’d have to fund operations from their own balance sheet on day one. That’s a real cost — and a legitimate reason for the peg to exist.

The peg is the target. It’s the dollar amount of working capital the buyer expects to be in the business at close. Hit the peg = no adjustment. Miss the peg = adjustment in the buyer’s favor (your check shrinks). Exceed the peg = adjustment in seller’s favor (surplus returned).

How the Working Capital Peg Adjusts Your Check at Close

Three scenarios at close: at peg, below peg, above peg. Each scenario has a different impact on the seller’s net proceeds — and the methodology for setting the peg dramatically affects which scenario you land in.

What Counts as Working Capital (And What Doesn’t)

Working capital is custom-defined in every M&A deal. The standard accounting definition (current assets minus current liabilities) is the starting point, but each LOI/SPA modifies it. Cash is usually excluded. Debt is always excluded. Some receivables are excluded. Some inventory is excluded. Each modification is a negotiation surface.

The components seller should fight to exclude

• Aged accounts receivable (over 90 days): argue these are non-current; many will never be collected anyway
• Obsolete or slow-moving inventory: push to exclude or write down before close
• Prepaid expenses for the buyer’s benefit: insurance prepays, software licenses that transfer to buyer
• Owner-related accruals: bonuses, vacation accruals attributable to the seller’s pre-close period

The components buyer will fight to include

• All receivables, regardless of age: they want the cushion
• All inventory: at full book value
• Customer deposits as a liability: these reduce working capital, so the seller must “leave” more

The Three Methodologies for Setting the Peg

How the peg target gets calculated is more important than the number itself. Three common methodologies exist; each biases the result differently.

Why methodology matters more than the headline number

A high peg with seller-friendly methodology beats a low peg with buyer-friendly methodology. Two LOIs both saying “working capital peg of $500k” can produce wildly different outcomes depending on whether the peg is set as a fixed dollar or as a moving target tied to a benchmark. Buyers know this; sellers usually don’t.

The Six Provisions to Negotiate at LOI

These six provisions determine whether the working capital peg quietly recovers 5-15% of price or stays neutral. Push for explicit language on each one before signing the LOI — once you’re in exclusivity, your leverage drops sharply.

1. Explicit calculation methodology

Spell out exactly how the peg will be calculated. Default seller language: “Working capital target shall equal the trailing twelve-month (TTM) monthly average of [specific line items], calculated consistent with the Company’s accounting policies in effect for the 24 months prior to close.” If the buyer pushes for trailing 3-month or same-month-prior-year, push back.

2. Defined exclusion list

Specify what is NOT working capital. Cash on hand: excluded (seller keeps). Debt: excluded (handled separately). Aged AR over 90 days: argue exclusion. Obsolete inventory: argue write-down or exclusion. Owner-related accruals: argue exclusion. The exclusion list belongs in the LOI — don’t punt to the SPA.

3. Measurement date

When is the peg measured? At close, end of month, or T-3 day? Measurement date matters because most service businesses have lumpy working capital (collections concentrated near month-end). A buyer-friendly measurement date can reduce your peg by 10-20%. Default seller language: “Measurement shall be at the end of the month immediately preceding closing, calculated from the company’s regular monthly close.”

4. True-up timing

When does the actual vs. peg comparison happen? Best practice: 60-90 days post-close, with seller representative right to review buyer’s calculation. Avoid: open-ended “within reasonable time after closing” or “buyer’s good-faith determination shall be final.” Sellers also want a hard deadline by which buyer must produce the closing balance sheet (60 days max).

5. Dispute resolution

How are calculation disputes resolved? Best practice: independent third-party accountant chosen from a pre-agreed list (Big-Four or similar regional firms), decision binding, costs shared based on outcome. Avoid: arbitration in buyer’s home jurisdiction, “buyer’s accountant shall determine,” or no dispute resolution mechanism at all (which means litigation).

6. Cap on adjustment

Negotiate a cap on the negative adjustment. Sophisticated sellers cap the working capital adjustment at 5-10% of headline price. Without a cap, a buyer’s aggressive accounting interpretation can reduce your check by 20%+. With a cap, the worst-case outcome is bounded.

Real Math: How a $500k Difference in Methodology Becomes $250k Out of Your Pocket

Same business, two different LOI clauses, dramatically different outcomes. Consider a home services business with average working capital that ranges from $400k to $700k month-to-month due to seasonal billing patterns. The buyer proposes: “working capital target of $700k.” Without methodology specified.

Scenario A: Seller accepts as written. At close, the buyer measures actual working capital on the 15th of the month (a deliberately chosen low point). Actual = $450k. Peg = $700k. Adjustment = -$250k. Seller’s check shrinks by $250k. Buyer just recovered 5% of headline price quietly.

Scenario B: Seller negotiates trailing 12-month methodology. Peg becomes the TTM monthly average = $550k (the actual run-rate of the business). At close, actual = $550k, exactly on peg. Adjustment = $0. Seller keeps full headline price.

Same business, same close date, same buyer. The only difference: two paragraphs of LOI methodology language. $250k of value transferred. Working capital peg is the buyer’s favorite place to recover money because most sellers don’t read it carefully.

How to Calculate Your Own Realistic Peg Before Going to Market

Before signing any LOI, run your own working capital analysis. Knowing your business’s normal range puts you in position to negotiate — and to spot when the buyer’s proposed peg is unrealistic.

1. Pull 24 months of monthly balance sheets. Most QuickBooks Online or accounting systems generate these.
2. Calculate working capital each month. Use a consistent definition: current assets (excluding cash) minus current liabilities (excluding debt).
3. Calculate the trailing 12-month average and seasonal range. Note the high, low, and median months. Identify why each is high or low (collections cycles, inventory builds, seasonal demand).
4. Compare buyer’s proposed peg to your TTM average. If buyer’s peg > 110% of your TTM average, push back hard.
5. Identify exclusion candidates. Old AR, obsolete inventory, owner-related accruals — each should be specifically excluded in the LOI.

Red Flags in Working Capital Clauses

Some working capital clause patterns are buyer-favorable signals. Spot these in the LOI and push back before exclusivity.

• No methodology specified — “Working capital target to be agreed” means buyer picks at close
• Buyer’s accountant determines — eliminates dispute resolution
• No exclusion list — cash, debt, aged AR all get rolled in
• Open-ended true-up timing — “within a reasonable time” means whenever the buyer’s CFO is ready
• No cap on negative adjustment — allows unlimited downward adjustment
• Methodology = same-month-prior-year for a seasonal business — deliberately favors the buyer
• Measurement on a non-month-end date — cherry-picking a low cash day

Working Capital Peg in the Context of the Full LOI

Working capital is one of seven LOI terms that decide your real number. The others — price, exclusivity, deal structure (asset vs. stock), earnout/rollover, post-close role, break-up fee — all interact with working capital. A buyer offering a high price with an aggressive working capital methodology is often offering less than a buyer with a lower price and clean working capital terms.

Conclusion

Working capital peg is the most important LOI term most sellers don’t negotiate. It’s technical, accounting-heavy, and deliberately complicated. But the math is simple: wrong methodology costs sellers 5-15% of the headline price quietly between LOI and close. Demand explicit methodology, a defined exclusion list, fair measurement date and true-up timing, dispute resolution, and a cap on adjustment. Run your own working capital analysis BEFORE going to market so you can spot a bad peg the moment it lands on your desk. The two paragraphs of LOI working-capital language can move 5-15% of headline price — treat them as the second most important negotiation in the document.

Frequently Asked Questions

What is a working capital peg in M&A?

A working capital peg (also called “target”) is the dollar amount of working capital the seller must leave in the business at closing. If actual working capital at close is below the peg, the seller’s check shrinks dollar-for-dollar. If above, the surplus is returned to the seller. The peg ensures the buyer doesn’t have to fund operations from their own balance sheet on day one.

How is the working capital peg calculated?

Three common methodologies: (1) trailing 12-month monthly average (most common, seller-friendly), (2) trailing 3-month average (favors sellers in growth scenarios but commits more cash), (3) same-month-prior-year (favors buyers for seasonal businesses). The peg should be calculated using consistent accounting policies and explicit definitions of what counts as working capital. Beware LOIs that don’t specify methodology — the buyer will pick the most aggressive one at close.

What’s typically included in working capital for M&A?

Standard inclusions: accounts receivable, inventory, prepaid expenses (current assets), accounts payable, accrued expenses, customer deposits (current liabilities). Standard exclusions: cash on hand (seller keeps), debt (handled separately under debt-free/cash-free mechanic), and sometimes aged receivables, obsolete inventory, or owner-specific accruals. Every deal customizes the definition.

How much can the working capital adjustment cost the seller?

On a $5M deal, working capital adjustments routinely move 2-7% of headline price (so $100k-$350k). Aggressive buyer-favorable methodology can push this to 5-15% ($250k-$750k). The lever is methodology and exclusion list. Without explicit terms in the LOI, the buyer chooses both, and the buyer always picks the methodology that recovers the most money.

Should cash be included in working capital?

No. In M&A deals using a “debt-free, cash-free” structure (which is most lower-middle-market deals), cash on hand is excluded from working capital. The seller keeps the cash; the buyer assumes no debt. Working capital is then defined as current operating assets minus current operating liabilities, both excluding cash and debt. If the LOI doesn’t say “debt-free, cash-free,” clarify before signing.

What’s the difference between working capital adjustment and earnout?

Working capital adjustment is a one-time settlement at close (or 60-90 days after) that adjusts the purchase price up or down based on actual working capital vs. the agreed peg. Earnout is contingent purchase price paid over 18-24 months tied to future business performance. Working capital adjustment is settled by accounting; earnout is settled by future operations. Both can affect final proceeds, but they’re distinct mechanisms.

When does the working capital true-up happen?

Standard timing is 60-90 days after closing. The buyer prepares a closing balance sheet, the seller (or seller’s representative) reviews, disagreements go to dispute resolution. Best practice: hard deadlines for buyer to produce the closing balance sheet (60 days max), seller’s review period (30-45 days), and a clear dispute resolution path. Avoid open-ended timing — it lets the buyer drag the process indefinitely.

Can I negotiate the working capital peg?

Yes — and you should. The peg, the methodology, the exclusions, the measurement date, the true-up timing, and the dispute resolution are all negotiable. Most owners ignore this section because it’s technical, which is why buyers win there. A 30-minute negotiation on working capital methodology can preserve 5-15% of headline price. Make sure your M&A attorney has explicit instructions to push hard on these terms.

What’s a ‘collar’ on working capital?

A collar limits the size of the working capital adjustment in either direction. Example: “Working capital adjustment shall not exceed +/- 5% of purchase price.” Sellers want collars because they bound the worst-case downward adjustment. Buyers sometimes resist collars because they want unlimited upside. A collar of 5-10% in either direction is a fair compromise.

What if the buyer claims the working capital is below peg by an unreasonable amount?

First, invoke your audit and review rights immediately. Second, hire an independent accountant to verify the buyer’s calculation. Third, formally dispute under the LOI/SPA notice procedures. Fourth, escalate to the agreed dispute resolution mechanism (third-party accountant). Most sellers who push back on aggressive buyer working capital claims recover 60-80% of the disputed amount — but only if you have explicit dispute resolution language and audit rights.

How is working capital different from net debt?

They’re different mechanics in the same overall deal structure. Net debt is total debt (short and long-term) minus cash. In a “debt-free, cash-free” deal, the seller pays off net debt at close (or buyer reduces purchase price by net debt). Working capital is current operating assets minus current operating liabilities, EXCLUDING cash and debt. Both adjustments happen, but they’re calculated and settled separately.

Should I run a working capital analysis before going to market?

Yes — absolutely. Before any LOI conversations, pull 24 months of monthly balance sheets, calculate working capital each month, and identify your TTM average and seasonal range. This prepares you to (1) negotiate a fair peg, (2) spot when the buyer’s proposed peg is unrealistic, and (3) plan post-LOI working capital management to land at or above peg at close. The analysis takes a CFO or sell-side accountant 4-6 hours.

Can the buyer reduce my purchase price after close based on working capital?

Yes — that’s exactly what the working capital adjustment does. If actual working capital at close is below the peg, the seller’s purchase price is reduced dollar-for-dollar. The reduction is paid from escrow or directly from the seller. Without proper LOI language (cap, methodology, dispute resolution), the buyer can effectively cut your check by 5-15% post-close with limited recourse.

About the Author

Christoph Totter is the founder of CT Acquisitions, a buy-side deal origination firm headquartered in Sheridan, Wyoming. CT Acquisitions sources founder-led businesses for 75+ private equity firms, family offices, and search funds across the U.S. lower middle market ($1M–$25M EBITDA). Christoph writes about M&A from the perspective of someone on the phone with both sides of the deal table every week. Connect on LinkedIn · Get in touch