A price for a business assumes the business arrives able to run: receivables that will turn into cash, stock on the shelf, suppliers paid on normal terms. The working capital peg says how much of that is enough, and the purchase agreement moves the price by every dollar the delivered working capital lands above or below it. It is one of the few numbers that can still move the price after both sides have agreed it.
The peg, also called the target or the normalized net working capital, is the level of net working capital the buyer and seller agree the business needs on the closing date. Delivered above it, working capital is paid for by the buyer, dollar for dollar; delivered below it, the shortfall comes off the price. This article sets out how the peg is set, what the definition leaves out, where the sign goes wrong, and a worked example.
Why the price needs a peg
An earnings multiple, and a discounted cash flow, already price a business that carries a normal level of working capital: the multiple pays for the earnings, and the earnings need the receivables, the inventory and the supplier credit to happen. The peg is not added to the price; it is the point of zero adjustment.
Without one, a seller could spend the last month before closing collecting every receivable, running inventory down and stretching every supplier, take the cash out, and deliver a business that cannot run. The peg also protects the seller: a business delivered with more than its normal working capital carries value the price did not include, and the adjustment pays for it.
What counts, and what the definition leaves out
Net working capital in a purchase agreement is narrower than current assets less current liabilities. The definition names the lines that count and must be applied the same way to the peg months and to the closing statement. Count income taxes in the peg months and exclude them at close, and the price moves by the taxes.
| Line | In the peg? | Why |
|---|---|---|
| Trade receivables, net of the reserve for doubtful accounts | In | Cash owed for work done, net of the agreed reserve |
| Inventory, net of the obsolescence reserve | In | Stock to be sold, net of the agreed reserve |
| Prepaid expenses and deposits paid | In, usually | Paid once, not paid again by the buyer |
| Trade payables | In | Suppliers the business owes on normal terms |
| Accrued operating liabilities: payroll, vacation, utilities, commissions | In | Operating costs incurred and not yet paid |
| Cash and cash equivalents | Out | Settled on the cash line of a cash-free, debt-free price |
| Bank debt, the operating line, current term debt, accrued interest | Out | Debt, settled on the debt line |
| Debt-like items: customer deposits, deferred revenue, pre-closing bonuses, earned severance | Negotiated | Argued deal by deal; the agreement names them |
| Income taxes payable or receivable, deferred taxes | Out | The seller's taxes for the seller's period |
| Balances with the seller and related parties | Out | Settled or forgiven at closing |
The rows marked negotiated are where the argument happens. Deferred revenue is cash the seller collected for work the buyer must now do, so a buyer calls it debt-like and a seller calls it an operating liability that was in every historical month; deposits, the bonus pool and earned severance raise the same question. The purchase agreement's definition governs, with an illustrative calculation attached as a schedule, and a transaction lawyer drafts it. The accounting policies it references decide the reading of every line.
How the peg is set
The standard method is the average of month-end net working capital over the trailing twelve months, each month restated on the agreement's definition. Twelve months is one full cycle of seasons, so a spring build and an autumn drawdown cancel, and one odd month moves the average by a twelfth of its size. The months are normalized before they are averaged: the same reserve policy in every month, one-off items taken out, and cut-off errors corrected.
The alternatives are argued by direction. A higher peg means the seller must deliver more working capital for the same price, so the buyer wants it high and the seller low. On a growing business the recent months carry more working capital than the year as a whole, so the buyer argues for the last three months and the seller for the full twelve; on a shrinking business the sides swap. Neither is wrong about the arithmetic; the argument is which months describe the business on the closing date.
Seasonality is the case that catches people. A business that peaks in late summer and troughs in February carries less working capital in February than in any other month. Close in February against a twelve-month average peg and the seller falls short by the normal seasonal gap, and pays for delivering the business in its ordinary condition. The fixes are a peg matched to the expected closing month, usually the same month in the prior year, or a schedule of pegs by month. Two further methods: an average of selected months, with the exclusions and the reason recorded, and a negotiated peg, legitimate as long as the reason is written down.
How the closing adjustment moves the price
Before closing the seller delivers an estimated closing statement, and the price paid on the closing date is adjusted by the estimate. Within a window the agreement sets, the buyer prepares the final closing statement; the seller accepts it or objects, and a dispute goes to an independent accountant whose decision on the accounting is final. The difference from the estimate is paid in cash or from escrow. A collar, a band around the peg within which no adjustment is made, or a cap on the adjustment, is a negotiated term, not a default.
The adjustment itself is dollar for dollar: delivered working capital minus the peg. Three places the sign goes wrong.
- Direction. Write it as delivered minus peg, so a positive result is money the buyer pays and a negative result comes off the price. Written as peg minus delivered, a shortfall reads as an amount the buyer owes.
- Negative working capital. A subscription business, a deposit-funded builder or a restaurant can run on negative net working capital, because customers pay before the cost is incurred, and its peg is negative too. Delivered working capital more negative than the peg is a shortfall, and the price comes down; readers get this backwards because a smaller negative looks like more.
- A level, not a flow. The peg is a balance on one date; the working capital deduction in a lender's cash available for debt service is the change in that balance over a year, and neither belongs in the other's line. The deduction and its sign conventions are set out in our article on cash available for debt service.
A worked example
Every figure in this section is a worked example. A buyer is acquiring a building-products distributor with revenue of about $3.6M, busy from late spring to early autumn and quiet in winter. The buyer's advisor restates month-end net working capital on the agreement's definition for the trailing twelve months:
May $290K Jun $302K Jul $312K Aug $321K
Sep $328K Oct $310K Nov $298K Dec $290K
Sum of the twelve months $3,540K
÷ 12 = Twelve-month average $295K
Average of the last three months (Oct to Dec) $299K
Same month last year, March $268K
The parties sign in December with closing expected at the end of March. The buyer's first draft proposes the average of the last three months, $299K; the seller's advisor answers that October to December sit on the downslope of the season and that March ran at $268K the year before. The twelve-month average, $295K, goes into the agreement as the peg, and nobody looks at the March figure again.
At the end of March the seller's bookkeeper prepares the estimated closing statement:
Cash $62K
Trade receivables $318K
Inventory $122K
Prepaid expenses $14K
Trade payables $142K
Accrued liabilities $41K (including $11K of income taxes payable and $3K of accrued interest)
Operating line of credit $85K
Seller's calculation, cash in and the line out
$62K + $318K + $122K + $14K − $142K − $41K = $333K
Claimed excess over the $295K peg $38K
The seller asks to be paid $38K on top of the price. The buyer's advisor reads the statement against the agreement's definition:
− receivables over ninety days, reserved under the agreed policies $9K
Inventory $122K
− obsolete stock per the closing count $6K
Prepaid expenses $14K
= Operating current assets $439K
Trade payables $142K
Accrued liabilities $41K
− income taxes payable, excluded $11K
− accrued interest, settled with the operating line $3K
= Operating current liabilities $169K
Delivered working capital $270K
Adjustment = delivered − peg = $270K − $295K = −$25K
The price comes down by $25K
The seller's $38K excess and the buyer's $25K shortfall are $63K apart, and not a dollar of it is working capital: the $62K of cash the seller counted comes out, and the seller keeps it on the cash line of the price; the $14K of tax and interest comes out of the liabilities, which raises the figure; the $15K of reserves the agreed policies require comes off. All of it was answerable in December.
Then the method. A peg matched to the expected closing month, $268K, would have turned the same closing statement into an excess of $2K, paid by the buyer. The $27K between the two outcomes is the choice of averaging method, which is why the method is argued before the price is final and recorded beside the peg. And the sign: written as peg minus delivered, $295K less $270K reads as $25K the buyer owes.
Educational guide, not advice. This guide is general information, not investment, legal, tax, accounting, lending or valuation advice. Rules, ratios, prices and worked figures are stated as of the date shown, are drawn from public sources and our own experience, and can be out of date or wrong; they are not a substitute for a lender's, regulator's or program's current rules. Verify any figure with its primary source and a qualified professional before acting on it.
How Acquiror AI does this
The Working Capital module in Acquiror AI unlocks once a deal's financials are extracted. Enter monthly, quarterly or annual periods with the balance-sheet lines, revenue and cost of sales, and the module computes DSO, DIO, DPO and the cash conversion cycle for each period on that period's own day count; a figure that cannot be computed shows a dash, never a zero. Import an AR aging to see which receivables are at risk, and set an inventory reserve override, with a tie-out warning when the balance sheet does not balance. Peg scenarios are built by more than one method, a 12-month average, a 3-month average, selected periods, a seasonal match to an expected closing month, or a manual peg with a recorded reason, and one is selected for the purchase agreement with its method recorded. The closing adjustment simulation takes a delivered working capital figure against a peg scenario and shows the variance above or below it, and the investment memo's working capital section carries the peg, the trends and the purchase-price adjustment. The module does not write the definition. The purchase agreement's definition governs, a transaction lawyer drafts it, and the module's figures are the analysis you bring to that drafting.
The takeaway
Set the definition first and apply it to every month. Average the months the business will look like on the closing date, and write the method beside the peg. Compute the adjustment as delivered minus peg, and read a negative peg with care. Someone who has read the agreement will argue the closing statement line by line; the only question is whose side they are on. Every term in this article is defined in the glossary.