Here's something I wish someone had told me earlier: the purchase price you negotiate is not the final number.
There's another negotiation coming—one that happens late in the deal, often catches first-time buyers off guard, and moves real dollars between you and the seller. QoE providers who see 50-60 deals a year consistently rank working capital disputes as the #1 source of friction in SMB acquisitions. Studies of private M&A show that 55% of deals result in a pro-buyer price adjustment at closing—often arriving as a surprise 60-90 days after close.
The good news: once you understand how working capital works, it's entirely manageable. This guide will walk you through everything you need to negotiate it with confidence.
What Working Capital Actually Is
Think of it this way: when you buy a business, you're buying a machine that produces cash flow. The enterprise value is the price of the machine. But every machine needs fuel to run. Working capital is that fuel—the money tied up in day-to-day operations that keeps the business functioning.
The basic formula:
Net Working Capital = Current Assets − Current Liabilities
In most acquisitions, we calculate this on a "cash-free, debt-free" basis:
Current assets: Accounts receivable, inventory, prepaid expenses (excluding cash)
Current liabilities: Accounts payable, accrued expenses, deferred revenue (excluding debt)
The seller keeps the cash and pays off debt. What remains is the operating liquidity you need to run the business from Day 1.
A Real-World Example
You're buying a landscaping company for $1.5M. The business typically carries $80K in receivables (customers who owe for completed jobs), $20K in prepaid expenses, and owes $40K to suppliers.
Normal working capital = ($80K + $20K) − $40K = $60K
Now imagine the seller, wanting to maximize cash before closing, aggressively collects receivables and delays paying suppliers. At closing, receivables are down to $30K and payables are up to $60K.
Closing working capital = ($30K + $20K) − $60K = −$10K
You're now $70K short of what you need to operate normally. Without a working capital mechanism in your deal, you just overpaid by $70K—or you're scrambling for a line of credit in your first month as owner.
Why This Matters for Your Deal
If the business doesn't come with enough working capital, you'll need to inject cash immediately after closing. That increases your effective purchase price and destroys your returns. Worse, it can create a cash crunch in your first 90 days—right when you're trying to learn the business and build trust with employees.
This is why the working capital "peg" exists—and why negotiating it correctly is one of the most important things you'll do in any acquisition.
How the Working Capital "Peg" Works
The peg is the agreed-upon target amount of working capital the seller commits to deliver at closing. It's typically based on the trailing 12-month average, which smooths out seasonal swings and gives you a normalized picture of what the business actually needs.
Here's how the adjustment works:
If at closing... | Then... |
Actual NWC is BELOW the peg | Seller pays you the difference |
Actual NWC is ABOVE the peg | You pay seller the difference |
Actual NWC equals the peg | No adjustment—clean close |
This is dollar-for-dollar. Every dollar the peg moves is real money changing hands. That's what makes this a zero-sum negotiation—and why the more prepared party usually wins.
The Tension You Need to Understand
You and the seller have opposite incentives on the peg:
You (the buyer) want the peg as high as reasonably justified. Higher peg = more working capital delivered, or a price reduction if they fall short.
The seller wants the peg as low as defensible. Lower peg = they can pull more cash out before closing.
Neither position is wrong—it's just negotiation. The goal is to land on a peg that reflects what the business actually needs to operate normally. When both sides focus on that, deals close smoothly.
Going Deeper: The Cash Conversion Cycle
Before you can negotiate effectively, you need to understand how much working capital the business actually requires. The Cash Conversion Cycle (CCC) tells you how long cash is tied up in operations:
CCC = Days Sales Outstanding + Days Inventory Outstanding − Days Payables Outstanding
A quick pre-LOI sanity check: multiply the CCC by average daily net sales. That gives you a ballpark working capital requirement you can compare against the seller's numbers. If there's a big gap, that's a conversation to have before you sign the LOI.
Analyzing Historical Working Capital
During diligence, you'll want to pull month-end working capital balances for the trailing 12-24 months. Look for:
Seasonality patterns: Does working capital spike before busy seasons? Drop after?
Trend direction: Is NWC increasing (growth requiring more capital) or decreasing (cash being pulled out)?
DSO/DPO changes: Have customer or vendor payment terms changed recently?
Anomalies: Any unusual spikes or dips that should be normalized?
Common Normalization Adjustments
Your QoE provider will identify adjustments to raw working capital figures. Common ones include:
Obsolete inventory: Slow-moving or unsellable inventory written down
Customer deposits: Often treated as debt-like items, not working capital
Out-of-term payables: Severely overdue AP classified as debt-like
Transaction-related accruals: One-time costs related to the sale
Cash-to-accrual conversion: GAAP adjustments if seller uses cash accounting
The Step-by-Step Playbook
Before the LOI: Do Your Own Math
Don't accept the seller's working capital number at face value. Run your own calculation using the financials in the CIM. Use the CCC × average daily sales formula as a quick sanity check.
If there's a material gap between your number and theirs, address it before signing the LOI—not during diligence when you've already committed time and money.
In the LOI: Get Specific
Your LOI should establish:
That a normalized level of working capital is included in the purchase price
The methodology (typically trailing 12-month average, subject to normalization adjustments)
That any difference results in a dollar-for-dollar price adjustment
The timeline for post-closing true-up (usually 60-90 days)
You don't need the exact peg number in the LOI—that's what diligence is for. But you do need agreement on how you'll calculate it.
During Diligence: Lean on Your QoE Provider
This is where a good QoE provider earns their fee. They'll analyze month-end working capital, identify normalization adjustments, flag red flags, and help you arrive at a defensible peg number.
In the Purchase Agreement: Define Everything
Vague definitions are where post-closing disputes come from. Your purchase agreement should include a sample calculation exhibit showing exactly which line items are included, which are excluded, and what accounting policies apply. Leave nothing to interpretation.
Red Flags to Watch For
As you analyze working capital, keep an eye out for:
Large YoY swings without clear seasonal explanations
Month-to-month volatility in gross profit (possible revenue recognition issues)
Seller's NWC estimate significantly lower than your calculation
CIM financials that don't reconcile to tax returns
Recent acceleration in AR collections or delays in AP payments
Customer deposits being treated as seller cash rather than obligations
Strange or aggressive add-backs in the seller's adjusted EBITDA
None of these are necessarily deal-breakers—but they're all worth understanding before you finalize terms.
SBA-Financed Deals
Most Main Street deals under $5M are structured cash-free, debt-free. The seller walks away with cash, you get the assets and operations. That means you're responsible for funding working capital from Day 1.
Options to consider:
SBA Working Capital Pilot: Lines of credit up to $5M for operating capital needs. Useful for flexibility, but doesn't fix a fundamental shortfall.
Monthly true-ups: For smaller deals, some parties agree to reconcile working capital monthly for 3-6 months post-close. More flexible than a rigid peg.
Bring your own: Some buyers plan to inject their own working capital. If you go this route, factor it into your total capital requirement.
What Happens After Close
Working capital can't be finalized at closing because the final account balances aren't available yet. The typical process:
Estimated NWC at close: Used for the initial purchase price calculation
60-90 day true-up: Buyer prepares closing balance sheet with actual figures
Seller review period: Typically 30-45 days to dispute calculations
Resolution: Agreement or escalation to independent accountant
Settlement: Wire transfer of any adjustment amount
Some deals use a "collar" mechanism where small differences (say, ±$25K) don't trigger an adjustment. This reduces friction over immaterial amounts while still protecting both sides from significant swings.
Timing Your Close
For seasonal businesses, when you close matters. If you buy a Halloween costume company on October 31st, you're inheriting a balance sheet that looks very different than it would in March.
If you buy at a seasonal low in working capital, you get a "discount" to enterprise value—but you'll need to invest that same amount to rebuild working capital over the coming months. You're no better or worse off on a net basis.
What matters is the peg. If you can negotiate a peg that favors you, that's real value. Seasonal timing is neutral. Peg negotiation is not.
The Bottom Line
Working capital isn't the most exciting part of a deal, but it's one of the most important to get right. A well-structured working capital mechanism:
Ensures you have the operating liquidity to run the business from Day 1
Prevents either party from gaming the numbers before close
Creates aligned expectations so there are no surprises at the finish line
Your action items:
Calculate your own NWC target before accepting the seller's number
Include explicit NWC provisions in your LOI
Engage a QoE provider to analyze working capital during diligence
Define every component and calculation method in the purchase agreement
Understand how seasonal timing affects your specific deal
The deals that close smoothly are the ones where both sides understand the methodology from the start. Do your math early, get specific in your LOI, and lean on your advisors during diligence. You'll close with confidence—and that's exactly how you want to start your ownership journey.
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Disclaimer: This guide is for educational purposes only and does not constitute legal, financial, tax, or investment advice. Business acquisitions involve significant risks, and outcomes can vary widely based on individual circumstances. Always consult with qualified professionals including attorneys, CPAs, and financial advisors before making acquisition decisions. The EBIT Community does not guarantee the accuracy of information provided or the success of any acquisition strategy. Past performance and examples do not guarantee future results.
