How Working Capital Adjustments Affect Your Deal Price

EBITDA gets all the attention, but working capital is where buyers quietly give money away.

Working capital is the cash tied up in running the business: inventory on shelves, receivables waiting to be collected, minus payables and accrued expenses owed to others. When you buy a company, you are buying a going concern. That means the seller needs to leave enough working capital behind for the business to function on Day 1.

If they do not, you will fund the gap with your own cash after closing. That cash does not show up in your purchase price. It just disappears.

The peg

How the target turns into a price adjustment

The peg is the negotiated target for transaction working capital. In plain English, it is the amount of working capital the seller agrees to deliver at close.

Mechanically, it becomes a purchase price adjustment:

• If working capital at close is below the peg, purchase price decreases by the shortfall.

• If working capital at close is above the peg, purchase price increases by the excess.

Example:

• Current assets (excluding cash) = $800K

• Current liabilities (excluding debt) = $300K

• Working capital = $500K

If the normalized peg is $450K and the close-date working capital is $400K, purchase price drops $50K. If it comes in at $500K, you pay $50K more.

The true-up is the second part of the mechanism. Closing balance sheets are estimates. The purchase agreement typically gives the buyer time post-close to calculate the actual close-date working capital, then settle the difference with the seller. A 60 to 90-day true-up window is common in middle-market style agreements.

That is why you negotiate the definitions early. The math is simple. The definitions are where the fight is.

The games

What sellers do right before closing (and how you catch it)

Sellers and their advisors know the close-date balance sheet matters. The tactics are predictable:

1. Stretching payables to make working capital look better (they delay paying vendors).

2. Pulling in receivables to make the close-date AR look cleaner (they pressure collections).

3. Starving inventory to generate cash before close (they stop reordering).

That last one is the most dangerous because you can "win" the purchase price adjustment and still lose economically.

I have seen distribution deals where inventory was run down for months ahead of a sale. Working capital looked great at close. The buyer closed. Then they spent the first 45 days refilling the warehouse, funded entirely out of operating cash flow and their own liquidity. The business did not break, but the "cheap" working capital delivery created a post-close scramble that could have been avoided.

The opposite game exists too. A seller can bloat working capital by buying extra inventory or letting AR drift. If your purchase agreement pays dollar for dollar above the peg, you can end up writing a check for working capital you will unwind shortly after closing.

The practical fix is boring: pull monthly balance sheets for 24 months, calculate working capital the same way every month, and graph it. The last six months are where the stories live.

Seasonality

Why your closing month matters more than your LOI language

A trailing 12-month average is a common starting point for a peg because it smooths noise. But averages can hurt you in seasonal businesses.

Example:

• Average working capital across the year = $600K

• March low = $400K

• July peak = $800K

If you set the peg at $600K and close in July, you may pay $200K above the annual average. In many businesses, that is effectively paying extra for a seasonal inventory build that will liquidate over the next few months.

If you close in a seasonal low, the seller will argue the peg is unfair. If you close in a seasonal high, you are the one at risk.

The right answer is not "always use 12 months." The right answer is: understand the seasonal pattern, then set a peg definition that matches the expected close date (or use a collar to limit the swing).

The diligence workflow

How to protect yourself without turning this into a science project

You do not need to be a transaction advisory firm to get this right. You need a consistent process:

1. Get 24 months of monthly balance sheets. (Not quarterly. Not annual.)

2. Agree on a working definition. Exclude items like cash, debt, and sometimes tax accounts, but be consistent with how the purchase agreement will define it.

3. Break working capital into components. AR, inventory, prepaid expenses, AP, accrued expenses, and other current items.

4. Graph the components. Seasonality shows up immediately. Manipulation shows up as a break from historical pattern.

5. Decide what "normal" looks like. Use the data, not the seller's story.

6. Protect the true-up. Escrows and collars are there for a reason. If the balance sheet is volatile, you want a mechanism that reduces the chance of a post-close fight.

Boring balance sheets are beautiful. Consistency tells you the peg is reliable and the business is predictable. Volatility tells you to dig deeper and protect yourself.

What's Next

Before you sign an LOI, compute a trailing 12-month working capital series using a single, purchase-agreement style definition. Then do three things:

1. Graph the monthly working capital trend over 24 months.

2. Identify seasonality and align it with your expected close month.

3. Flag any change in trend in the last six months and push for explanations (and protections) before you lock price.

Sources

• Schneider Downs Capital, "Deal Me In: Close and Settle-up" (working capital estimates, true-ups, and common timing)