Glossary
Working Capital Peg
A working capital peg is the target level of net working capital a seller must deliver at closing in an acquisition. If actual working capital is above the peg, the price rises; if below, it falls. It ensures the buyer receives a normal level of operating liquidity.
Formula
Example
A buyer and seller agree to a $20,000,000 purchase price and a working capital peg of $2,500,000, based on the trailing twelve month average. At closing, net working capital (receivables plus inventory minus payables and accrued expenses) is $2,200,000. The $300,000 shortfall reduces the price to $19,700,000. Had closing working capital been $2,650,000, the seller would have received $150,000 more.
How it is used in underwriting
Purchase prices are usually set on a cash-free, debt-free basis with a normal level of working capital. Without a peg, a seller could collect receivables aggressively, run down inventory or delay paying vendors before closing, extracting cash that the buyer would then need to replace. Underwriters typically set the peg from a monthly average of net working capital over the trailing twelve months, which smooths seasonality, using the definitions from the quality of earnings report. The agreement then sets an estimated adjustment at closing and a final true-up, often 60 to 120 days later, with a dispute mechanism.
Most peg disputes come from definitions, not arithmetic. The purchase agreement should specify which accounts are included, how reserves for bad debt and obsolete inventory are calculated and which accounting policies apply. Cash, debt and income taxes are usually excluded, while items such as customer deposits or accrued bonuses are frequently negotiated as debt-like. Seasonal businesses need special care, since closing during a peak or trough can produce a large adjustment. Sellers sometimes negotiate a collar, a band within which no adjustment occurs, and lenders should confirm the peg leaves the business with adequate liquidity after funding.
Frequently asked questions
How is a working capital peg calculated?
The peg is usually based on the average monthly net working capital over the trailing twelve months, adjusted for one-time items and calculated using the definitions in the purchase agreement. Net working capital generally includes receivables, inventory and prepaid expenses minus payables and accrued liabilities, excluding cash, debt and income taxes.
What happens if working capital is below the peg at closing?
If closing working capital falls short of the peg, the purchase price is reduced dollar for dollar by the shortfall, either at closing based on an estimate or at the final post-closing true-up. Some agreements fund this from an escrow or holdback so the buyer can collect without pursuing the seller.
Is the working capital peg negotiable?
Yes. The peg is often one of the most negotiated economic terms after price. Sellers prefer a lower peg and buyers a higher one. Disagreements usually involve which months to average, how to treat seasonality, and whether specific items such as deferred revenue or customer deposits count as working capital or debt.
Related terms
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