The Working Capital Peg in a Business Acquisition: What It Is and Why It Matters at Closing

Two buyers can sign at the same purchase price, and one walks out of closing with cash in the bank while the other walks out $25,000 lighter and doesn't find out until payroll. Working capital is the difference, and most first-time buyers never put it on the table.

It decides how much cash is actually in the business the morning after you own it. And it's a transfer hidden inside the price, not a line item bolted on next to it. Treat it as a back-office detail for the lawyers and you'll fund the first ninety days out of your own pocket, servicing acquisition debt with one hand while you float payroll and payables with the other.

What working capital means here

Working capital is the cash and near-cash the business needs to run day to day, minus what it owes short-term. Current assets like receivables and inventory, less current liabilities like payables.

In most deals the seller delivers a normal level of it as part of the purchase price, so the business can run from day one without you putting more cash in. That's where buyers get hurt. It's part of what you're buying, and if nobody negotiated the level, nobody's guaranteeing it.

It lives on the balance sheet, which is why reading the P&L alone won't ever show it to you. A profitable business can hand over an empty checking account and a pile of bills.

Easiest way to think about it: profit is what the business earned, working capital is the fuel left in the tank. It's the same gap as profit on paper versus cash actually in the business, and it decides whether you make payroll in week two.

Why does the business need fuel at all? Because it pays for labor and materials before customers pay their invoices, so it always has to hold enough cash to cover that stretch. Buy it with the tank empty and you cover that stretch yourself, starting the morning after close.

The peg is a negotiation

The peg is the target level of working capital the seller agrees to deliver at close. It's usually set from a trailing twelve-month average of what's normal for the business.

The formula looks objective, but somebody picks the inputs. What the peg really decides is who funds the first quarter, and the dollars move whether the spreadsheet looks neutral or not.

Set it right and the business carries its own first quarter. Set it low and you've agreed, without noticing, to bankroll the seller's last one.

So the two of you pull it in opposite directions:

• The seller wants it low. A lower target means they keep more cash and collect more receivables on the way out.
• You want it adequate. A peg set off a thin month leaves the business short the day you take over.
• You both fight over "normal." Seasonality, a slow recent quarter, or one big unpaid invoice can swing the trailing average by tens of thousands of dollars.

That's why the peg belongs in the same conversation as the rest of your deal terms with the seller, where it gets the same attention as the price. A seller who's financing part of the price has even more reason to push it down, since it frees up cash they'd otherwise leave behind.

Accept a trailing average without checking which months it covers and you've accepted the seller's framing.

How it settles at the table

The adjustment's a true-up. You compare the working capital actually delivered at close against the agreed peg, and cash moves to settle the difference.

Take a commercial electrical service company you're buying. The peg's set at $120,000, and at close the business delivers $95,000 of net working capital. That's $25,000 short, so the purchase price drops by $25,000 or the seller wires the difference, and you're made whole for the missing fuel.

It runs the other way too. If the business delivers $140,000 against a $120,000 peg, you owe the seller $20,000 for the extra.

That's how two buyers at the same headline price close at different real prices. One negotiated a peg that protected their cash, and the other inherited an empty tank and paid the same sticker. Count the true-up among the cash needs that land at the closing table, next to the down payment and fees, because it can move either direction and you won't know which until the closing balance sheet's final.

Where a thin peg bites

A low peg doesn't announce itself at close. It shows up six weeks later, when the receivables haven't turned into cash yet and the payables are due.

Walk the cash through. If you financed the purchase (often with an SBA 7(a) loan), you're paying that debt out of what the business produces.

• Month one: payroll, rent and supplier invoices come due right on schedule.
• Weeks four to eight: the receivables you bought are still being collected, so cash in lags cash out.
• The gap: if the delivered working capital was thin, you cover it from personal cash, on top of the loan payment.

That's the hit. The business can be truly profitable and still squeeze a new owner who funded the deal but not the float. And it's worst in month one, when you've got the least slack: the loan payment's fixed, the receivables are in transit, and a thin peg means nothing's standing between the two.

The seller's numbers never show you any of that. Put working capital inside the bigger question of what the business is actually worth to you, and a thin peg turns out to be a quiet markdown on the deal you thought you negotiated.

It's worse if the business also leans hard on its owner. That kind of operation is fragile already, and pairing it with a starved cash position means the first slow quarter lands straight on the new owner, and that combination is what sinks new owners in year one.

Protecting yourself in diligence

Do this before you sign. It's verifcation work, and it goes in the same pass as the rest of your diligence on the balance sheet.

1. Define the peg in writing. Pin down the target, the trailing period it's built from, and exactly which accounts count, before the purchase agreement's final.
2. Test the trailing months. Pull twelve months of balance sheets and check whether the average reflects a normal cycle or a flattering window the seller picked.
3. Age the receivables. Make sure what's in the target is collectible. Stale invoices pad the delivered number without ever turning into cash.
4. Stress the first quarter. Model ninety days running on the delivered working capital alone, loan payment included, and confirm it clears.

If it doesn't clear, either the peg's wrong or the price is. Both are reasons to renegotiate, and finding that out is the whole point of diligence.

Put the peg on the table in your first terms conversation, before the seller sets it for you.

FAQ

What is working capital in a business acquisition?

Working capital in a business acquisition is the cash and near-cash assets a business needs to operate, minus its short-term liabilities, delivered to the buyer as part of the purchase price. It is the operating fuel that lets the business run from day one without the buyer injecting more cash.

What is a working capital peg?

A working capital peg is the target level of net working capital the seller agrees to deliver at closing, usually set from a trailing twelve-month average. If the business delivers less than the peg, the price adjusts down or the seller pays the shortfall; if it delivers more, the buyer pays the difference.

Who pays for working capital in an acquisition?

Working capital is paid for through the purchase price, not on top of it, because the seller delivers an agreed level as part of the deal. The closing true-up then settles any gap between the peg and the actual balance, so whoever delivered too little or too much owes the difference.

You cannot protect a cash position you have not measured.

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