Working Capital Adjustment When Selling a Business
How the working capital peg is set, how the post-close true-up works, and how sellers can protect themselves from losing $200K–$1M+ at the closing table without understanding why.
What is the working capital peg?
When you sell your business, the buyer isn't just acquiring your assets or stock — they're acquiring an operating enterprise that needs working capital to function. Accounts receivable, inventory, and prepaid expenses are the "fuel" already in the tank. Accounts payable, accrued salaries, and other current liabilities are obligations the business owes right now.
The working capital peg is a negotiated target: the amount of net working capital (NWC) the seller agrees to deliver at closing. If you deliver exactly the peg, no adjustment occurs. If you deliver more than the peg, the purchase price goes up by that amount. If you deliver less, the purchase price goes down.
The peg is almost always set based on your business's historical working capital level — typically a trailing 12-month (TTM) average. The logic is that the buyer is paying for a fully operational business, not a cash-stripped shell. If you collected every receivable before close, paid every vendor, and ran down inventory, the business would require immediate capital infusion after closing. The working capital mechanism prevents that.
The working capital formula
Working capital is current assets minus current liabilities — but the definition of "current assets" and "current liabilities" is negotiated, not fixed. Standard inclusions and exclusions for M&A purposes:
| Component | Typical treatment | Negotiation note |
|---|---|---|
| Accounts receivable | Included | Aging cutoff varies — buyers often exclude AR over 90 days as uncollectible |
| Inventory | Included | Valuation method (FIFO vs LIFO) and obsolescence reserves are heavily negotiated |
| Prepaid expenses | Often included | Insurance prepaid is usually included; some software subscriptions are not |
| Cash and equivalents | Excluded | Cash is handled separately (seller typically retains it or receives it via a "cash-free / debt-free" mechanism) |
| Accounts payable | Included (as liability) | Sellers may try to accelerate payment before close to reduce this — counterproductive, it reduces the NWC you deliver |
| Accrued liabilities | Included (as liability) | Accrued vacation/PTO and accrued bonuses are major traps (see below) |
| Deferred revenue | Included (as liability) | Subscription businesses often have significant deferred revenue; can cause large WC shortfalls |
| Short-term debt / current portion of long-term debt | Excluded | Handled via the "debt-free" mechanism; seller pays off all debt at close |
| Income taxes payable | Often excluded | Tax liabilities up to close are typically the seller's responsibility, handled separately |
The exact line items and their treatment must be agreed on before the peg is set. This negotiation happens at the letter of intent stage — or should. Many sellers let the buyer propose the peg calculation methodology at LOI signing without scrutinizing it, and discover the problem at close.
How the peg level is determined
The peg is almost always set at the "normalized" working capital level — what the business typically carries, not what it happens to hold on a specific date. Three common methodologies:
Trailing 12-month (TTM) average
Calculate monthly working capital for each of the last 12 months, average them. This is the most common approach for businesses with seasonal variation. Seller advantage: if your business is seasonal and you're closing in a low-WC month, the TTM average will be higher than your closing balance — you may owe the buyer a shortfall. Know your seasonal pattern before negotiating this methodology.
Trailing 3-month average
More favorable for sellers closing in a high-WC period; less favorable for those closing in a low-WC period. Some buyers prefer this because it's more reflective of current conditions.
Spot date (a specific month's balance)
Occasionally used when the business has no meaningful seasonality. Sellers should resist using a month that was unusually high; buyers will target months that were unusually high.
The true-up process
At closing, the purchase price is adjusted based on an estimated working capital figure — typically the most recent month-end balance sheet. The actual closing-date working capital isn't known precisely until the books are fully closed, which takes weeks.
The typical true-up timeline:
- At close: Purchase price adjusted using estimated WC. If estimated WC = $2.1M and peg = $2.0M, seller receives $100K extra. This is a preliminary, not final, adjustment.
- 30–90 days post-close: Buyer prepares a "closing statement" with the actual closing-date WC, calculated on a methodology agreed in the purchase agreement. The typical deadline is 60–90 days.
- Seller review period: Seller (and their advisors) get 30–45 days to review and dispute the buyer's closing statement. If there are disputes, the parties negotiate. If unresolved, the dispute goes to a neutral accounting firm for binding arbitration.
- Final adjustment: If actual WC < estimated WC used at close, seller owes buyer the difference (paid from escrow). If actual WC > estimated, buyer pays seller.
The adjustment flows through escrow. Most purchase agreements require an escrow holdback of 1–2% of enterprise value specifically to cover WC adjustments and rep & warranty claims.
Five common working capital traps for sellers
1. Accrued vacation and PTO
Accrued but unpaid vacation time is a current liability. If your employees carry 30–45 days of vacation, the accrued PTO balance may be $200K–$500K in a 50-person company. Sellers often forget to include it when estimating their WC delivery. At close, this liability increases working capital shortfall dollar-for-dollar.
What to do: Know your PTO accrual balance. If it's large, either negotiate to exclude it from the WC calculation or factor it into your price expectation from the start.
2. Deferred revenue in subscription businesses
If customers pay annually in advance, you carry deferred revenue as a liability — cash received but service not yet delivered. A SaaS or software business with $1M in annual contracts might carry $400–600K in deferred revenue at any point in the year. The buyer treats this as a current liability (they'll have to deliver the service), reducing your net working capital.
What to do: Some sellers successfully negotiate to exclude deferred revenue from the WC calculation (arguing it's a "transition item" and not really working capital in the traditional sense). Others negotiate a lower peg that accounts for the structural deferred revenue level. Neither is automatic — it must be addressed in the purchase agreement.
3. Pre-paying vendors or collecting receivables aggressively before close
Some sellers, seeing the closing date approaching, try to improve their cash position by collecting receivables faster than usual or deferring vendor payments. Both can backfire: aggressively collecting AR reduces the AR balance (and therefore the working capital you deliver). Pre-paying vendors adds to the prepaid expense balance but may not be reflected correctly in the peg.
What to do: Run the business normally in the final 60–90 days before close. Artificial manipulation of WC balances is often treated as a breach of the ordinary course covenant in the purchase agreement.
4. Accrued bonuses and year-end compensation
If your business accrues year-end bonuses and the deal closes in Q4, you may have a large accrued compensation liability that inflates current liabilities. Conversely, if the deal closes in Q1 before bonuses are accrued, buyers will often argue the accrual should be included in normalized WC based on historical patterns.
What to do: Understand your historical bonus accrual timing and how it affects your monthly WC profile before the peg is set.
5. Inventory write-downs discovered at closing
Buyers sometimes commission an independent inventory appraisal as part of due diligence. If obsolete or slow-moving inventory is identified that wasn't adequately reserved for on your books, the buyer will reduce the inventory value in the closing statement, creating a WC shortfall you didn't anticipate.
What to do: Perform a sell-side inventory review 6–12 months before going to market. Identify and write down obsolete inventory proactively — it's better to show a clean, lower inventory balance going into the process than to have the buyer discover it during due diligence.
How to negotiate the working capital peg
The LOI stage is where the peg negotiation should happen — not after a definitive agreement is nearly signed. Key negotiating levers:
Peg calculation methodology
Push for the methodology to be specified in the LOI, not left to the purchase agreement. "Working capital will be calculated consistent with the company's historical accounting practices" is vague and leads to disputes. Specify: (1) which line items are included, (2) the measurement date (TTM vs 3-month average vs specific month), and (3) how tie-breakers are resolved.
Peg level
The buyer will propose a peg based on their version of your trailing WC. Before accepting any proposed peg, calculate it yourself using the agreed methodology. A sell-side QoE that includes working capital analysis is the best way to understand your own WC profile before the buyer does.
It's common for sellers to negotiate a peg slightly below the TTM average — a "minimum peg" rather than an exact target — so that normal monthly variance doesn't automatically create a shortfall. A $50K–$100K cushion below the average can be reasonable to request for deals where WC fluctuates meaningfully month to month.
True-up timeline and dispute process
Negotiate a tight timeline on the closing statement (60 days is standard; push back on 90 days) and ensure the dispute resolution process specifies a neutral accounting firm, not "an accounting firm mutually agreed" (which can be paralyzed by disagreement).
Escrow structure
Understand how much of the WC adjustment flows through escrow versus direct payment. If WC adjustments can create a liability greater than the escrow holdback, negotiate a cap or an alternative payment mechanism that doesn't require a post-close cash payment from you personally.
Working capital in asset sales vs stock sales
The mechanics are similar but the accounting treatment differs:
Stock sale: The buyer acquires the entire legal entity, including all assets and liabilities on the balance sheet. Working capital is naturally transferred as part of the entity. The peg mechanism ensures the buyer receives the expected level rather than a stripped-down balance sheet.
Asset sale: The buyer selects which assets and liabilities to acquire. In most asset sales, AR and inventory are acquired assets; AP and accrued liabilities may or may not be assumed. The WC mechanism still applies but the included line items must be defined very specifically, since "current assets" isn't a default transfer in an asset deal.
What working capital means for your financial plan
A $500K post-close WC shortfall is a $500K reduction in after-tax proceeds — money you had planned for post-sale investing, charitable giving, or estate planning. If that proceeds plan was built on a $10M after-tax figure, arriving at $9.5M changes the math on a Roth conversion ladder, a CRT funding target, or a post-sale portfolio income estimate.
Fee-only exit planning advisors who specialize in this niche model the WC risk as part of the overall transaction analysis — not as an afterthought. The advisor coordinates with your M&A attorney on the purchase agreement language and with your accountant on the historical WC calculations that set the peg. The earlier this coordination begins, the more leverage you have.
Get ahead of the working capital peg
A fee-only exit planning advisor can help you model your working capital profile, stress-test the peg under different closing date scenarios, and identify adjustments that could reduce your risk before you're in a live process.
Sources
- AICPA — Working Capital in M&A Transactions: Common Disputes and Best Practices
- SEC Division of Corporation Finance — Current Assets and Liabilities Classification
- SBA — Managing a Business Sale: Understanding Deal Terms
- Journal of Accountancy — Working Capital Disputes in M&A Transactions
Working capital mechanics described here reflect general market practice for mid-market business sales as of 2026. Specific deal terms vary by transaction, industry, and buyer type. This page does not constitute financial, tax, or legal advice.