If deal structure determines what you sell and tax strategy determines what you keep, then working capital determines whether you start your post-exit life in a good mood or staring at a surprise adjustment you never saw coming.
Working capital is one of the least understood — yet most important — components of an M&A deal. And within that world, the working capital peg is the number both sides negotiate to ensure the business is delivered with a “normal” level of working capital at closing.
Get this wrong, and buyers can claw back hundreds of thousands (or millions) from your proceeds.
Get it right, and you protect value, avoid disputes, and ensure a smooth closing.
In The Entrepreneur’s Exit Playbook, I explain it this way:
“Buyers don’t just buy your business. They buy the fuel that keeps it running.
That fuel is working capital.”
At Legacy Advisors, we help founders understand and negotiate working capital pegs early so they aren’t blindsided later. This article breaks it all down.
What Is Working Capital in an M&A Deal?
Working capital represents the short-term financial health of a business — the cash and liquid assets required to run day-to-day operations.
The basic formula:
Working Capital = Current Assets – Current Liabilities
But in M&A, it’s rarely that simple.
Buyers and sellers negotiate which accounts “count” and which don’t. Typical working capital includes:
Included:
- Accounts receivable
- Inventory
- Prepaid expenses
- Accounts payable
- Accrued expenses
Excluded:
- Cash (usually)
- Debt (always)
- Taxes payable
- Non-operational liabilities
The goal is to determine the operational working capital required to keep the business functioning on Day One after closing.
What Is a Working Capital Peg?
A working capital peg (sometimes called a “target working capital”) is the agreed-upon amount of working capital the seller must deliver at closing.
Think of it like a fuel gauge:
The buyer expects the tank to be at a certain level when they take the keys.
If working capital at closing is below the peg → the seller pays the buyer a shortfall.
If it’s above the peg → the buyer may owe the seller the excess (depending on the contract).
The peg protects the buyer from a seller who might:
- Delay paying bills
- Collect receivables early
- Burn inventory
- Reduce expenses
- Run the business “lean” to improve cash at close
The peg ensures fairness.
But the way it’s calculated matters.
Why Buyers Care So Much About Working Capital
Buyers need to ensure the business can operate normally the day after closing — without immediately injecting more cash.
Working capital protects buyers from:
- Unexpected cash shortages
- Seasonal fluctuations
- Declining collections
- Inflating payables
- Vendor disputes
- Inventory depletion
If working capital is too low, the buyer inherits a crisis.
If it’s too high, the buyer benefits from liquidity the seller never intended to give away.
The peg creates balance.
Why Sellers Must Understand Working Capital Early
Founders often ignore working capital until the end — and pay the price. A poorly negotiated peg can wipe out months of negotiation wins.
Common mistakes include:
- Using only one month of historical data
- Including anomalous years (like COVID)
- Not adjusting for seasonality
- Allowing buyers to use trailing twelve-month (TTM) averages that don’t reflect future operations
- Agreeing to a peg in the LOI without expert review
- Misclassifying assets or liabilities
Your CPA, attorney, M&A advisor, and tax strategist must align before you negotiate working capital terms.
How the Working Capital Peg Is Calculated
There are several standard methods — each with strategic implications.
1. Historical Average (Most Common)
Buyers analyze working capital over:
- 12 months
- 24 months
- 36 months
They remove extremes and calculate an average.
This method is fair — but founders must ensure:
- Seasonality is accounted for
- Abnormal periods are excluded
- Growth is factored in
- Lost or new customers are considered
2. Seasonal Peg
For businesses with seasonal swings, working capital may need to reflect:
- Busy-season levels
- Slow-season levels
- Inventory build cycles
Retailers, agriculture businesses, and distributors often use this method.
3. Forward-Looking Peg
If the company is growing fast or undergoing major changes, historical averages don’t reflect future needs.
Forward-looking pegs use:
- Forecasted working capital
- Budgeted revenue and expenses
- Growth-adjusted receivables and inventory needs
This method protects high-growth companies from artificially low pegs.
4. Minimum & Maximum Range (Collars)
Instead of a single peg, some deals use a range.
Example:
Working capital peg = $1.2M ± $150K
This gives sellers protection from minor fluctuations and reduces the risk of a dispute.
Working Capital Disputes: One of the Most Common Deal Killers
Working capital adjustments are the No. 1 source of post-closing disputes.
Why? Because:
- Assumptions differ
- Definitions differ
- Accounting policies differ
- Accrual methods differ
- Forecasts differ
- Incentives differ
Buyers want the peg high.
Sellers want the peg low.
Clarity and precision are non-negotiable.
What Belongs — and Does Not Belong — in the Peg Calculation
Common Buyer Additions:
- Deferred revenue
- Customer deposits
- Long-term payables
- Extraordinary accruals
Common Seller Exclusions:
- Owner distributions
- Non-operational liabilities
- Cash
- Income tax liabilities
- One-time expenses
The key is to create a peg that reflects normal operations — nothing more, nothing less.
Why the LOI Is the Most Dangerous Place to Negotiate Working Capital
Many founders sign an LOI with vague terms like:
“Working capital to be included at a normal level consistent with historical performance.”
That language is a trap.
It leaves “normal” open to interpretation — and the buyer gets to interpret it after exclusivity begins.
Your M&A advisor must negotiate:
- How the peg is calculated
- What period is used
- What accounts are included
- What adjustments apply
- Whether collars are used
- The calculation methodology
- The dispute resolution process
All before the LOI is signed.
Once you’re in exclusivity, working capital leverage is gone.
The Role of Your Deal Team in Working Capital Negotiation
Your M&A Advisor
Leads negotiation, models scenarios, and protects the seller from inflated pegs.
Your CPA
Analyzes historical working capital, normalizes calculations, and identifies distortions.
Your Attorney
Ensures definitions and methodology are airtight in the purchase agreement.
Your Tax Strategist
Evaluates tax implications of certain working capital classifications.
Your Internal Finance Lead
Provides data, supports forecasting, and ensures accuracy.
Working capital is a team sport.
Practical Example: How a Bad Peg Hurts Sellers
Scenario:
Company’s normal working capital is $800K.
Buyer pushes for a peg of $1.2M based on outdated seasonality.
If the seller agrees:
- They “give away” an extra $400K of working capital.
- Their take-home proceeds decrease by $400K.
- Their tax outcome worsens depending on classification.
This scenario happens constantly — and sellers rarely see it coming.
Practical Example: How a Good Peg Protects Value
Scenario:
Company’s working capital fluctuates seasonally from $700K to $1.8M.
Averages vary wildly depending on time frame.
The M&A advisor negotiates:
- A seasonal peg tied to current-year performance
- A collar of ± $250K
- Exclusions for abnormal COVID years
This structure protects the seller from volatility and prevents buyer manipulation.
Lessons from Experience
During my exit from Pepperjam, working capital negotiations were one of the most complex parts of the deal — more complex than valuation, more complex than reps and warranties.
I saw firsthand how careful modeling, proactive negotiation, and expert coordination reduced risk and avoided post-closing disputes.
That experience shaped our philosophy at Legacy Advisors:
Founders should understand working capital before the buyer walks through the door — not during late-stage diligence.
The Valuation Advantage
Proper working capital negotiation:
- Prevents post-closing clawbacks
- Protects seller proceeds
- Reduces buyer suspicion
- Speeds closing
- Lowers risk
- Improves the relationship post-deal
- Strengthens confidence in numbers
A fair peg is a value-protection tool.
A sloppy peg is a value-destruction trap.
Final Thoughts
Working capital pegs are not accounting details.
They are negotiation levers.
They are risk management tools.
And they are one of the most important determinants of your final take-home number.
Exits don’t happen when you feel ready — they happen when your business is ready.
And part of readiness is understanding the financial mechanics that protect your legacy.
Find the Right Partner to Help Sell Your Business
At Legacy Advisors, we help founders model, negotiate, and defend working capital pegs that protect value and eliminate surprises. We work closely with your CPA, tax strategist, attorney, and finance team to ensure your peg is fair, clear, and strategically sound.
Visit legacyadvisors.io to connect with our team, explore insights from The Entrepreneur’s Exit Playbook, and listen to the Legacy Advisors Podcast (https://legacyadvisors.io/podcast/). Together, we’ll help you avoid the working capital pitfalls that catch founders off guard.
Frequently Asked Questions About Working Capital Pegs
What exactly is a working capital peg in an M&A deal?
A working capital peg is the agreed-upon amount of working capital the seller must deliver to the buyer at closing. It ensures that the business has enough short-term liquidity—inventory, receivables, prepaid expenses, payables, etc.—to operate normally on Day One post-transaction. If the company’s working capital at closing is below the peg, the seller owes the buyer the shortfall. If it’s above the peg, the seller may receive a positive adjustment depending on the contract. As explained in The Entrepreneur’s Exit Playbook, “Buyers aren’t just buying your business—they’re buying the fuel that keeps it running. That fuel is working capital.”
How is the working capital peg calculated?
Most commonly, the peg is based on a 12–36 month historical average of working capital, adjusted for seasonality, abnormal periods, customer losses/gains, and future organizational needs. Other methods include seasonal pegs, forward-looking pegs (used for fast-growth companies), and collars that create a permissible range instead of a single number. Your CPA and M&A advisor typically model multiple scenarios to determine what a “normal” working capital level truly is. The key: don’t rely on a single month or a simplistic average—precision matters.
Why is working capital such a big deal for buyers?
Without enough working capital, the buyer must immediately inject cash to keep the business running. Working capital protects the buyer against issues like slow collections, high payables, inventory shortages, and seasonal fluctuations. A company delivered with too little working capital is a liability. A company delivered with too much gives the buyer an unfair windfall. This is why buyers push hard for higher pegs—and why sellers must be prepared to defend what “normal” really means.
What mistakes do sellers commonly make when negotiating working capital pegs?
The biggest mistake is agreeing to vague LOI language such as “normal working capital consistent with historical levels.” That ambiguity gives buyers enormous leverage later, when exclusivity has already begun. Other common mistakes include failing to account for seasonality, using distorted COVID-era or recession data, misunderstanding which assets/liabilities “count,” and not involving the CPA early enough. These errors can cost sellers hundreds of thousands—or millions—in post-closing adjustments.
How can Legacy Advisors help founders negotiate a fair working capital peg?
At Legacy Advisors, we model working capital trends before buyer outreach begins. We coordinate your CPA, attorney, tax strategist, and internal finance team to build a defensible peg grounded in accurate historical and forward-looking data. We negotiate peg methodology inside the LOI—before exclusivity—so there are no surprises later. Drawing from strategies in The Entrepreneur’s Exit Playbook and deal-by-deal lessons discussed on the Legacy Advisors Podcast (https://legacyadvisors.io/podcast/), we help founders avoid clawbacks, reduce disputes, and protect final proceeds by ensuring the peg is fair, clear, and aligned with true business operations.