The Net Working Capital Peg for Founders
When selling a business, most owners naturally focus on valuation and purchase price. However, some of the most important deal terms are buried in the details of the purchase agreement. One of those terms is the net working capital peg—a provision that can directly impact the proceeds you receive at closing and potentially lead to post-sale disputes if it isn’t properly understood.
In this video, Kirk Michie breaks down what a net working capital peg is, why buyers insist on it, and what business owners should pay attention to before agreeing to the terms. Watch the video below to learn how this often-overlooked provision can affect your transaction.
Understanding the Net Working Capital Peg
When founders think about selling their business, they tend to focus on valuation, purchase price, and deal structure. Yet one of the most important terms in a transaction often receives far less attention: the net working capital peg.
While it may sound like an accounting detail, a working capital adjustment can directly impact the amount of cash you receive at closing. It’s also one of the most common sources of post-closing disputes between buyers and sellers.
Before signing a letter of intent, it’s worth understanding how this provision works and why buyers care so much about it.
What Is a Net Working Capital Peg?
A net working capital peg is a target amount of working capital that the business is expected to have when the transaction closes.
The purpose is simple: buyers want to receive a business that can continue operating normally on day one after the acquisition. They don’t want to immediately inject cash into the company just to make payroll, pay vendors, or purchase inventory.
Think of it like selling a car with a full tank of gas. The buyer expects the business to be delivered in a condition that allows it to keep running without interruption.
How Is Net Working Capital Calculated?
Every deal is different, but net working capital is typically calculated using operating assets and liabilities such as:
Accounts receivable
Inventory
Accounts payable
Accrued expenses
Certain tax liabilities
One important distinction is that most transactions are completed on a cash-free, debt-free basis. That means cash and debt are usually excluded from the working capital calculation.
As Kirk often reminds founders, this is “deal math” rather than traditional accounting math. The exact definition matters, and small changes to the formula can significantly impact the final adjustment.
Why Do Buyers Require a Working Capital Peg?
The working capital peg is designed to create a fair starting point for both parties.
Without it, a seller could potentially collect receivables, delay paying vendors, or otherwise reduce working capital before closing, leaving the buyer responsible for funding normal operations immediately after the acquisition.
By establishing a target level of working capital, both sides agree on what “normal” looks like.
The goal isn’t to reduce the purchase price. The goal is to ensure the business is transferred in the same operating condition it has historically maintained.
How Is the Working Capital Target Determined?
In most transactions, buyers calculate the peg by analyzing historical financial statements and determining the company’s average working capital over time.
Common approaches include:
Trailing 12-month averages
Monthly averages
Quarterly averages
Seasonally adjusted calculations
For businesses with significant seasonal swings, the methodology becomes especially important. A retailer preparing for the holiday season, for example, may carry dramatically more inventory than at other times of the year.
This is why founders should review the assumptions behind the calculation rather than focusing only on the final number.
Why Do Working Capital Disputes Happen After Closing?
Working capital adjustments are one of the most common causes of post-closing disagreements.
Disputes often arise around:
Collectability of receivables
Inventory valuation
Accrued expenses
Tax liabilities
Timing of payments and invoices
Classification of balance sheet accounts
Many founders spend considerable time negotiating valuation while paying little attention to the working capital language buried in the letter of intent or purchase agreement.
That can be a costly mistake.
The Key Takeaway for Founders
The net working capital peg may not be the most exciting part of a transaction, but it can have a meaningful impact on your proceeds.
If the business is delivered with less working capital than the agreed-upon target, a portion of the purchase price may be returned to the buyer. If it is delivered with more working capital than required, you may receive additional proceeds.
Either way, the most important time to understand the formula is before signing a letter of intent.
As we often tell clients, the letter of intent establishes the framework for the final deal. Terms rarely become more favorable later in the process. Taking the time to understand the working capital provisions upfront can help avoid surprises and protect the value you’ve spent years building.
