What is a working capital peg?

A peg is set by averaging the business's net working capital over a trailing period, usually measured month by month, so the buyer is not paying for a business that looks different on closing day than it does across the year.

Net working capital is the operating assets that turn into cash minus the operating liabilities you owe in the short run. On the asset side that means accounts receivable, inventory, and prepaid expenses. On the liability side it means accounts payable, accrued payroll, and customer deposits. In a cash-free, debt-free deal, cash and interest-bearing debt sit outside the calculation, because you keep the cash and pay off the debt from proceeds.

The buyer's accountants usually build the first schedule as part of their diligence, and the same month-end data feeds a quality of earnings report. They then adjust the average for seasonality, one-time items, and any month where your books were distorted. A landscaper or a roofer with a heavy spring will not have the same balance in January as in June, and the peg has to reflect the level the buyer needs to run the next season without injecting cash.

For how pegs are built across deal sizes and how the adjustment mechanics are drafted, read the working capital peg guide. Before you go to market, ask your CPA to produce a month-end net working capital schedule for the last twelve months, so you propose the peg instead of reacting to the buyer's number.

A peg moves your price dollar for dollar at closing: you are paid more if the business delivers more working capital than the peg, and less if it delivers less.

Here is an illustrative example. Take a business with $1,000,000 in revenue and $250,000 in SDE. SDE drives the headline price, and the peg does not change that price. It only adjusts it at closing. Assume, for illustration only, that the twelve month-end net working capital balances add up to $960,000. The average is $960,000 divided by 12, which is $80,000. That is the peg. Now assume two hypothetical closing balances, $65,000 and $95,000, and compare each to the peg.

A shortfall happens when an owner stretches payables, lets receivables age, or runs inventory down before closing to pull cash out. Buyers test for exactly that pattern, and the peg is the mechanism that charges you for it. In an asset sale the receivables and payables may not transfer at all, which changes what counts toward the peg, so read asset sale vs stock sale before you agree to a definition.

Run the calculation on your own balances before the LOI, so you know whether the buyer's proposed peg sits above the level your history supports or below it.

Negotiate the definition of working capital, the averaging period, and the true-up process before the LOI, because the peg is hardest to move after exclusivity begins.

1. Included accounts. List each receivable, inventory, prepaid, payable, and accrual line by name, so nothing is added later.
2. Exclusions. Cash, debt, income taxes, owner loans, and related-party balances should sit outside the calculation.
3. Averaging period and seasonality. Agree on the trailing months used and how a seasonal peak or trough is treated.
4. A collar. A band around the peg inside which no adjustment is made keeps small variances from becoming disputes.
5. True-up and disputes. The purchase agreement should set an estimated closing adjustment, a post-closing true-up, and an independent accountant to decide disagreements, limited to the disputed items.

Also require that the closing statement use the same accounting methods as the schedule behind the peg. If the buyer switches how it reserves for bad receivables, the same balance sheet produces a lower number and you pay for the method change.

Put these five terms in the LOI draft with your advisor and your attorney, because a peg that first appears in the purchase agreement is a negotiation you start after you have already granted exclusivity.