You’ve spent decades building your company. You’ve successfully navigated the marketing process, found a qualified buyer, and signed a Letter of Intent (LOI) with a headline price that reflects your hard work. You might think the finish line is in sight.

However, in the mid-market M&A world, the "Headline Price" is rarely the "Final Check." One of the most common—and most dangerous—areas where value erodes is during the final accounting reconciliation. This is known as the working capital adjustment in M&A.

At an experienced M&A advisory firm, we often see founders lose between 5% and 10% of their total deal value simply because they didn't understand how to define and negotiate the "Peg." This article will pull back the curtain on this silent value leak and show you how to protect your sale price through disciplined negotiation and foresight.

1. Introduction – The Price You See Is Not Always the Price You Keep

The "Working Capital Trap" is a phenomenon where a buyer agrees to a high enterprise value upfront, only to "claw back" hundreds of thousands—or even millions—at the closing table. They do this by setting an unfair benchmark for how much liquidity must be left in the business.

This benchmark is called the Working Capital Peg.

Think of the peg as the "gas in the tank." When you sell a car, the buyer expects it to have enough fuel to get home. In a business sale, the buyer expects the company to have enough "fuel" (cash, inventory, and receivables) to operate the next day without them having to inject more capital immediately. If you deliver the business with less fuel than agreed upon, the buyer deducts the difference from your purchase price.

With experienced M&A guidance, our mission is to ensure that the "gas" you leave behind is a fair amount—not a windfall for the buyer at your expense.

2. What Is Working Capital?

In plain English, working capital is the money tied up in the daily operations of your business. Technically, it is defined as:

Current Assets – Current Liabilities = Working Capital

What’s Included?

• Accounts Receivable (AR): Money customers owe you for products/services already delivered.
• Inventory: Raw materials, work-in-progress, and finished goods.
• Prepaid Expenses: Items you’ve already paid for that provide future value (e.g., insurance).

What’s Excluded?

• Cash: Most mid-market deals are "cash-free/debt-free," meaning the seller keeps the cash in the bank but must pay off all bank debt before closing.
• Indebtedness: Any bank loans or long-term debt.
• Transaction Expenses: Legal and advisory fees related to the sale.

The buyer wants to ensure that the Accounts Receivable are collectible and the inventory is not obsolete. If these numbers are inflated, your working capital looks higher than it actually is.

3. How the “Peg” Works in M&A

The "Peg" is the target amount of working capital the seller is expected to deliver at the moment of closing. It is usually based on a historical average of the business’s needs.

The Mechanics of Adjustment

The final purchase price is adjusted based on the difference between the Actual Working Capital at closing and the Negotiated Peg.

• Actual < Peg: The Purchase Price is reduced dollar-for-dollar. (Common)
• Actual > Peg: The Purchase Price is increased dollar-for-dollar. (Rarely agreed to by buyers without a fight)

A Numerical Example:

• Headline Price: $20,000,000
• Negotiated Peg: $2,000,000
• Actual Working Capital at Closing: $1,600,000
• The Result: You receive $19,600,000. You just lost $400,000 because the "gas in the tank" was lower than the buyer's benchmark.

4. Why Sellers Get Caught in the Trap

Sellers often fall into the trap because they treat working capital as a "back-office accounting issue" rather than a primary negotiation point.

The Vague LOI

Many buyers leave the working capital definition vague in the LOI, stating it will be "based on a mutually agreed-upon normalized level." This is a red flag. By the time you get to the definitive agreement, you have lost your leverage (exclusivity), and the buyer can dictate a "normalized" level that favors them.

Ignoring Seasonality

If your business peaks in December, your working capital will naturally be higher then. If the buyer sets the peg based on your peak month but you close in a "slow" month, you will almost certainly trigger a massive price reduction.

The "Double Dip"

Buyers sometimes try to categorize an item as "Debt" (which reduces your price) and *also* include it as a "Current Liability" in the working capital calculation. This is "double-dipping" on the same expense to lower your proceeds twice.

5. Negotiating a Fair Peg

To protect your business sale valuation, you must be proactive. You cannot let the buyer’s accountants define "normal."

Use Rolling Averages

Standard practice is to use a 12-month rolling average (T12M). This smooths out monthly spikes and dips. However, if your business is growing rapidly, a 12-month average might be too low, as your current needs are higher than they were a year ago. In this case, a 6-month or even 3-month average may be more appropriate.

Normalize the Data

"Normalization" means removing anomalies. Did you have a one-time inventory surge for a specific project? Was there a delay in a major payment? These should be adjusted out of the historical data to ensure the peg reflects a *standard* operating day.

6. The Role of Financial Diligence

You shouldn't wait for the buyer to do their due diligence. an experienced M&A advisor recommends a Sell-Side Quality of Earnings (QoE) report.

A QoE report prepared by an expert accountant allows you to present the buyer with a "clean" version of your working capital. It identifies "add-backs" and ensures that your accounting methodology (e.g., how you value inventory or recognize revenue) is consistent. Consistency is your best defense; if you change how you calculate working capital mid-stream, the buyer will use that inconsistency to demand a higher peg.

7. Common Buyer Tactics

Sophisticated buyers (especially Private Equity firms) have "playbooks" for the closing statement in M&A.

• The Inventory Write-Down: During diligence, the buyer may claim 20% of your inventory is "slow-moving" and exclude it from Assets. This lowers your actual working capital and triggers a price reduction.
• The Accrual Push: The buyer may insist on including "accrued bonuses" or "accrued vacation" as liabilities, even if you’ve never tracked them that way, effectively increasing the liabilities and lowering your WC.
• The "Net" Trap: They may try to include "Current Portion of Long-Term Debt" in the calculation. Since debt is already handled in the "cash-free/debt-free" adjustment, including it here is a classic double-dip.

8. An Experienced M&A Advisor’s Working Capital Defense Strategy

With experienced M&A advisory support, we use a four-step framework to ensure our clients don't lose money to accounting maneuvers.

• Baseline Analysis: We perform an internal audit of your working capital cycles 24 months back. We identify the peaks, valleys, and "one-offs."
• Early Peg Definition: We push to define the specific methodology (e.g., "T12M Average of GAAP-consistent Current Assets minus Current Liabilities") in the LOI, *before* exclusivity begins.
• Strict Documentation: We ensure the Purchase Agreement contains a detailed "Sample Calculation" exhibit. This leaves zero room for the buyer’s accountants to "interpret" the math differently at closing.
• Closing Oversight: We work with your CPAs during the 60-day post-closing reconciliation period to challenge any adjustments the buyer tries to make.

9. Case Insight: The $400K Save

A manufacturing client was selling for $15M. The buyer proposed a peg of $1.8M based on the last three months of the year—the client’s busiest season. an experienced M&A advisor intervened, proving that the business’s true annual average was $1.4M. By fighting for a normalized working capital peg, a $400,000 "haircut" to the purchase price that would have happened automatically on closing day was prevented.

Final Takeaway – Define Everything, Assume Nothing

In M&A negotiation, the "Big Number" gets the headlines, but the "Small Print" determines the wealth. The working capital peg is one of the most powerful levers the buyer has to change the deal in their favor at the eleventh hour.

The rule of thumb is simple: Define the methodology early, document the exclusions clearly, and never let the buyer’s accountants define what is "normal" for your business.

With experienced M&A guidance, we handle the nuances of the closing statement so you can focus on your legacy. We ensure that when you cross the finish line, the price you agreed to is the price you keep.

Before signing your LOI or purchase agreement, contact an experienced M&A advisor for a confidential review of your working capital peg. Protect your deal value from silent erosion and hidden adjustments.

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Working capital negotiation in M&A considerations are particularly relevant for business owners across Northeast Ohio — Cleveland, Chagrin Falls, Cuyahoga County, and Geauga County — where a high concentration of privately held businesses in the $1M–$5M revenue range operate across industrial, services, and trades sectors. Owners in this market deserve advisors who understand both the transaction and the regional context in which it occurs.

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Business owners across Northeast Ohio preparing to close a transaction engage Ben Calkins to define and defend the working capital peg before exclusivity begins — not after the buyer's accountants have already set the terms.

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Ben Calkins | Fast Forward Business Advisors

M&A Advisory — Northeast Ohio

Call directly: 440-595-4300

Schedule a Confidential Consultation

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