The working capital peg: where sellers lose money at closing

You agree on a price. You sign the letter of intent. Somewhere in the purchase agreement there is a paragraph about delivering a normal level of working capital at closing, and most owners read it once and move on. Ninety days later there is a true-up calculation showing you owe the buyer three hundred thousand dollars.

This is the single most common way a deal that felt fair turns into one that does not.

What the peg is for

A buyer paying for a going concern expects to receive one. If you collect every receivable, stop paying vendors, and run inventory to nothing in the sixty days before closing, you have quietly moved cash from the business into your pocket, and the buyer inherits a company that needs an immediate injection to operate.

The peg prevents that. It sets a target level of working capital, typically an average of the trailing twelve months, and adjusts the price up or down based on what you actually deliver. In principle it is fair to both sides. In practice it is the least-negotiated number in the transaction, and it is set by the buyer's accountants using the buyer's definitions.

Where the money actually leaks

The averaging period

A seasonal business measured on a trailing twelve-month average and closed at its seasonal peak will deliver far more working capital than the target requires. That surplus is yours in theory. Whether you get paid for it depends on language nobody read.

Receivable quality

Your balance sheet says $800,000 in receivables. The buyer's accountant reserves everything over ninety days and half of everything over sixty. Your $800,000 becomes $640,000, and the gap comes out of your proceeds unless the agreement defines how aging is treated.

Inventory

Same mechanic, more subjective. Obsolete or slow-moving inventory gets written down against you, using a standard the buyer selects, at a moment when you have almost no leverage left.

Accrued liabilities you never thought of

Unused employee vacation. Customer deposits for work not yet performed. Warranty obligations. Sales tax accrued but not remitted. Each of these is a real liability and each one reduces working capital. If they were not in the baseline calculation but are in the closing calculation, you pay for them twice.

What to do about it

• Raise it before the LOI. That is when you have competition and leverage. After signing, you are negotiating with someone who knows you have stopped talking to anyone else.
• Attach a worked example. Not a definition, an actual schedule with real numbers from a real month, agreed by both sides and stapled to the letter of intent. Ambiguity always resolves against the seller.
• Define what is excluded. Cash, debt, deferred revenue, and anything else being handled separately in the price. Say so explicitly.
• Pin the aging and reserve methodology. Which receivables count, at what age, with what reserve. Do not leave it to a policy the buyer names later.
• Set a collar and a dispute mechanism. A dead band where small variances do not trigger an adjustment, and a named independent accountant to resolve disagreements, with a deadline.

None of this is exotic. It is standard practice in larger transactions and routinely skipped in smaller ones, which is exactly why smaller sellers are the ones who get surprised.