Working Capital Peg: What It Is and How It Is Set in a Sale

Working Capital Peg: What It Is and How It Is Set in a Sale

A working capital peg is the target amount of working capital a seller agrees to leave in the business at closing. If the company closes with less, the price goes down. If it closes with more, the price can go up. The peg exists so a buyer does not pay full price for a business that has been emptied of what it needs to run.

System Six, a Seattle bookkeeping and fractional CFO firm whose profile mentions post-acquisition finance modernization, is the one Sam's List member named near the end. System Six is a paid featured member of Sam's List.

What Is a Working Capital Peg?

A working capital peg is a benchmark for net working capital, which is current assets minus current liabilities, that a purchase agreement sets as the level the business should deliver at closing. It is also called a target or a base. Buyers ask for one because most deals are priced on the assumption that the business keeps running normally on day one.

Take a company with a normal level of receivables and inventory, and imagine the owner collects every receivable in the final weeks and pays out the cash before closing. The buyer would then own a business that needs cash just to fund the next payroll. The peg stops that by tying the price to a working capital level.

The limitation: a peg protects the buyer's expectation of normal operations. It does not protect against a bad business, and it only works as well as the definitions behind it.

Net Working Capital Adjustment and Purchase Price Adjustment

A net working capital adjustment is one kind of purchase price adjustment: a change to the headline price after closing, based on what the balance sheet actually looked like. Here is how the pieces fit.

Term	Plain meaning	When it happens
Working capital peg	The target level of net working capital	Agreed before signing
Estimated closing working capital	The seller's best estimate at closing	At closing
Net working capital adjustment	Price moves up or down by the gap to the peg	At closing and after
True-up	The final recount using actual closing numbers	Weeks or months after closing

The limitation: some deals use other price adjustments too, such as for debt or transaction costs. A working capital adjustment is one piece of the price mechanics, not all of them.

How a Working Capital Peg Is Commonly Set

The common method is a trailing average of normalized net working capital. The parties take monthly balance sheets over a recent period, often 12 months, remove one-time items, and average the result. An average handles seasonality: a retailer holds more inventory in the fall than in January, so a single month can mislead.

An invented example. Suppose a company's normalized monthly net working capital averages $1.2 million over the last 12 months. The parties set the peg at $1.2 million. If the closing balance sheet shows $1.1 million, the price drops by $100,000. If it shows $1.3 million, the price can rise by $100,000, depending on how the agreement is written.

Buyers and sellers negotiate the period and the adjustments. In a growing business, a recent period shows a higher need, so a buyer often argues for it while a seller argues for a longer average that pulls the peg down. Either side may also argue for a full year to account for a seasonal peak.

The limitation: there is no single required formula. Averages, periods and adjustments are all negotiated, so a number from one deal says little about another.

What a Working Capital Peg Usually Excludes

Cash, debt and income taxes are usually carved out of working capital. The reason is that those items are typically handled somewhere else in the price. Many deals are priced on a cash-free, debt-free basis, so the seller keeps the cash and pays off the debt, and neither one should also show up in the working capital number.

Other items often get specific treatment, such as accrued bonuses, deferred revenue, customer deposits and related-party balances. Whether they count in the peg is a negotiation, which is why the definition matters more than the dollar figure.

The limitation: which line items count is decided deal by deal. A category that is excluded in one agreement may be included in another, so read the definitions in your own draft.

The Post-Closing True-Up

At closing, the numbers are an estimate. A few weeks or months later, the buyer typically prepares a closing balance sheet, the seller reviews it, and the final working capital is compared with the peg. The difference is paid one way or the other. Most agreements describe a review window, a way to dispute items and sometimes an independent accountant who decides open points.

This is where a loose set of books costs money. If the seller cannot support an accrual or the buyer cannot tie out a balance, the argument runs on the quality of the records.

The limitation: the process and deadlines come from the purchase agreement, not from a standard. Missing a review deadline can mean accepting the other side's numbers.

Where Books Quality Changes the Number

Net working capital is only as reliable as the books it comes from. Three problems move it most. Receivables that are old or uncollectible overstate it. Liabilities that were never recorded, such as bills received but not entered, understate the liabilities. And inconsistent accounting from one month to the next makes the trailing average hard to trust.

A seller who has monthly closes, reconciled accounts and written accounting policies can defend a peg. A seller without them often finds the buyer's numbers become the starting point of the conversation.

The limitation: clean books help you argue your number, but they do not decide it. The agreement's definitions decide it.

Where a Finance Partner Fits

Setting a peg and running a true-up is accounting work, and many owners do not have a team for it. A fractional CFO or bookkeeping firm can build the monthly balance sheets, normalize them and prepare the closing schedule.

System Six is a Seattle firm, founded in 2009, that does bookkeeping and fractional CFO work for small businesses with between $1 million and $10 million in revenue. Its live profile says the firm was acquired by a searcher in 2021 and that it helps organizations modernizing a finance function after an acquisition. The profile does not describe peg negotiation, so ask whether purchase price adjustments are in scope. See the System Six profile.

System Six has too few verified reviews on Sam's List for a count to be meaningful, so we describe the firm by what its profile says and do not cite one. System Six is a paid featured member of Sam's List.

The limitation: System Six lists a $1 million revenue minimum, with monthly fixed fees starting at $800 a month, so smaller companies may be out of range. A finance firm prepares the numbers. The definitions are negotiated by the parties and drafted by attorneys, so you still need a lawyer on the agreement. A firm named here is a starting point, not a verdict, and you can compare fractional CFOs on Sam's List.

Frequently Asked Questions

What is a working capital peg?

A working capital peg is the target level of net working capital a seller agrees to deliver at closing. If actual working capital at closing is below the peg, the purchase price is reduced. If it is above, the price may increase, depending on the agreement. It keeps the buyer from paying full price for a depleted business.

How is a working capital peg calculated?

Commonly as a trailing average of normalized monthly net working capital, often over about 12 months, excluding cash, debt and income taxes. The period and adjustments are negotiated, so there is no single formula. Your accountant prepares the numbers and your attorney writes the definition into the agreement.

Is a net working capital adjustment the same as a purchase price adjustment?

Not exactly. A net working capital adjustment is one type of purchase price adjustment. Others can cover debt, cash or transaction expenses. The working capital version compares closing working capital to the peg and moves the price by the difference.

Can I negotiate the peg?

Yes. The peg, the look-back period, the accounting policies and the excluded items are all negotiated. Sellers and buyers often disagree, so bring support from your monthly financials and have your accountant and attorney review the draft before you sign.

If a sale is on your horizon, pull 12 months of balance sheets now and see what your own average looks like before a buyer does it for you.

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About the author: Kimberly Green is cofounder of Sam’s List, a directory and matching platform for financial professionals.