The working capital peg, explained for searchers

Agreeing a price does not settle what operating balances the seller will deliver at closing. A business may need receivables and inventory to support its next operating cycle while also carrying unpaid supplier bills. The working capital discussion asks which of those balances transfer and what level the agreed price assumes.

For a searcher, the useful output is a defined schedule, a supported target and a clear adjustment process. Confirm the definitions, accounting treatment and agreement language with your QoE provider, accountant and counsel. This guide is preparation for that discussion, not legal, accounting or tax advice.

Define the balances before choosing a number

Net working capital broadly means current assets minus current liabilities. Transaction net working capital is a negotiated calculation. The agreement may include selected operating balances and exclude cash, financing debt and items handled elsewhere in the price calculation. Do not copy the balance sheet's current-asset and current-liability totals without reviewing the accounts.

A starting discussion might cover trade receivables, inventory, operating prepayments, trade payables and operating accruals. Ask how customer deposits, deferred revenue, taxes, related-party balances and unusual liabilities will be treated. Their classification needs transaction-specific advice. Something labeled "current" in the accounts is not automatically part of the peg.

Build an account-by-account schedule that states what is included, what is excluded and where excluded items are addressed. Keep the same definition when measuring history, setting the target and calculating the closing balance. Otherwise, the comparison can change because of classification rather than operations.

Understand the peg and the true-up

The peg is the agreed target level of transaction working capital. Under a common adjustment approach, closing working capital above the peg increases consideration and a shortfall reduces it. An estimated closing calculation may set the initial payment, followed by a post-close calculation and settlement of the difference. The purchase agreement determines the actual mechanism.

RSM's working capital peg explanation describes the target, purchase-price adjustment and importance of seasonality. Treat these as concepts to work through with your advisors, not terms that automatically apply to your acquisition.

The peg is not an extra cash reserve. Receivables still need to be collected, and inventory still needs to be sold. Keep the balances delivered by the seller separate from the opening cash you need to fund payroll, transaction costs and the next operating cycle.

Build a normalized monthly history

Ask your QoE provider for the periods and detail needed to assess the business. Bring monthly balance sheets and supporting receivables, inventory and payables schedules. Review the QoE preparation guide before turning a generic request for financials into an advisor's work plan.

Trailing-average approaches are common starting points to discuss. A monthly average over a full annual cycle can reduce dependence on one closing date, but it is not automatically the right target. Compare the proposed closing month with the same season in earlier years. Ask whether growth, a changed customer mix or revised supplier terms makes older balances less representative.

Discuss unusual balances and proposed adjustments individually. Do overdue receivables need a reserve? Is inventory usable? Are payroll and supplier accruals complete? Have invoices landed in the correct period? RSM's working capital negotiation overview identifies reserves, accruals, cutoff, growth and seasonality as issues to examine.

Keep reported balances, proposed normalization adjustments and the resulting monthly schedule in separate columns. Ask the provider to explain the evidence for each adjustment. An average calculated precisely from inconsistent monthly accounts can still be a poor basis for negotiation.

Work through one closing adjustment

Synthetic example. The business, monthly balances and agreement mechanics below are invented. This is arithmetic for a discussion with advisors, not proposed contract language.

Assume the parties include only net trade receivables, inventory, trade payables and operating accruals. Net receivables already reflect the agreed reserve. They exclude cash and all debt from this calculation and handle them elsewhere. There are no other working capital accounts in this example.

After review, the defined monthly working capital is $180,000 for each of the first six months and $220,000 for each of the next six months. The annual monthly average is:

(6 × $180,000 + 6 × $220,000) ÷ 12 = $200,000.

Assume the parties review seasonality and agree to use that $200,000 peg. This assumption does not establish that an annual average would suit another transaction.

Included balance	Closing estimate	Final closing calculation
Net trade receivables	$280,000	$270,000
Inventory	$100,000	$100,000
Less trade payables	($140,000)	($150,000)
Less operating accruals	($30,000)	($30,000)
Transaction net working capital	$210,000	$190,000

Assume consideration before this adjustment is $1,500,000 and all other price adjustments are zero. The agreement in this illustration adjusts consideration dollar for dollar for the difference from the peg.

At closing, estimated working capital exceeds the peg by $10,000. The initial consideration is therefore $1,510,000. The final calculation is $10,000 below the peg, so final consideration is $1,490,000. The post-close true-up is a $20,000 payment from seller to buyer, bringing the initial $1,510,000 down to $1,490,000.

The $20,000 settlement reflects the change from the estimate to the final calculation. It is not another $20,000 deduction from final consideration. Keep the peg comparison and the settlement calculation separate so the same shortfall is not counted twice.

Raise the mechanism before the LOI is settled

Use the LOI preparation guide to organize the discussion with counsel. At a high level, ask the LOI to address the intended working capital basis, how the target will be established through diligence and the proposed closing adjustment process. Have counsel determine the wording and its legal effect.

If the records do not support a number yet, identify the missing work and when the parties will revisit the target. A placeholder described as preliminary is easier to evaluate than a precise figure with no schedule behind it. Do not let "normal working capital included" stand in for a shared understanding of what normal means.

Before signing the purchase agreement, ask your advisors to walk through a sample calculation using the proposed definitions. Confirm who prepares the estimate and final statement, what records each party can inspect, the review timetable and how disagreements are resolved. Ask counsel and the lender how settlement obligations will be funded or secured under the chosen structure.

Keep the adjustment connected to funding

Ignoring the peg can leave the parties discussing different economics at the same headline price. The seller may expect to collect receivables while the buyer assumes those balances remain. Missing accruals or unusable inventory can also make the delivered amount look stronger than the operations it supports.

Map each finding to its treatment with the advisors. A debt-like item should not quietly appear in both a separate debt deduction and the working capital shortfall. Keep any earnings effect distinct from the balance-sheet treatment, and explain when both are justified.

Update sources and uses when expected consideration changes. Separately model cash needed after closing and revisit debt service coverage if collections or inventory requirements change. A price adjustment can compensate for a shortfall without making cash available before the next payroll date.

SearchWare's acquisition underwriting supports sources and uses and saved scenarios. Its LOI and offer workflow connects offers to saved underwriting and tracks revisions. Keep the advisor-reviewed peg schedule with your deal records, review plans, and start a SearchWare trial with one acquisition case.