The Net Working Capital Peg: The Closing-Table Fight Nobody Warns First-Time Sellers About

The net working capital peg is the amount of working capital (receivables plus inventory minus payables, roughly) that the seller must deliver with the business at closing, at no extra charge. It exists because a company isn't a machine you unplug and hand over: it needs fuel in the tank (billed invoices, stocked shelves, normal payables) to keep operating on day one. The peg is typically set at the trailing twelve-month average NWC, and at closing the actual balance is compared to it: short and the price drops dollar-for-dollar; over and the buyer pays the excess.

In my M&A experience, on transactions from Main Street size up to the multi-billion-dollar corporate deals I worked on earlier in my career, I can tell you the working capital schedule starts more closing-week arguments than the purchase price does. Price gets negotiated once; the peg gets measured, and measurement is where deals get emotional.

Why "Cash-Free, Debt-Free" Isn't the Whole Story

Most private deals are quoted cash-free, debt-free (CFDF): the seller keeps the cash, pays off the debt, and hands over the operating business. First-time sellers hear that and assume they also keep the receivables and get paid extra for inventory. Usually wrong, and the misunderstanding is expensive.

The buyer's logic: the price was set as a multiple of the earnings the business produces, and producing those earnings requires a normal level of working capital. Deliver the business empty (receivables collected, inventory sold down, payables stretched), and the buyer must immediately inject cash just to make payroll and restock. Same company, worse deal. The peg is the mechanism that stops both sides from gaming the tank level between signing and closing.

How the Peg Is Set (and Fought Over)

The standard: trailing twelve-month (TTM) average NWC, computed from monthly balance sheets, with a matching true-up at closing:

Three fights repeat in almost every deal:

• Definition games. Whether deferred revenue, customer deposits, or accrued bonuses count as working capital or as debt-like items can move the effective price by more than the last round of price negotiation did. This is precisely the schedule the Quality of Earnings process exists to pin down: the QoE firm typically proposes the NWC definition and peg alongside its earnings adjustments.
• Seasonality. A retailer closing in October carries peak inventory; a TTM average peg forces the seller to hand over far more than a "normal" level for that date. Seasonal businesses should negotiate a seasonally adjusted peg (same-month prior-year, or a defined seasonal curve).
• Quality, not just quantity. Hitting the peg with 90-day-past-due receivables and dead stock satisfies the number, not the intent. That is why definitions increasingly specify collectible AR and saleable inventory.

A Worked Example

A distribution business sells for $4.0M CFDF. TTM average NWC (the peg) is $600K.

• At closing, actual NWC is $450K (the seller collected receivables hard in the final quarter to pocket the cash). Price adjusts down $150K to $3.85M. The seller effectively handed themselves the buyer's money.
• Had actual NWC come in at $700K (a seasonal inventory build), the buyer would pay $100K extra, protecting the seller from donating stock.

Net effect: the seller's "harvest the balance sheet before closing" instinct is exactly neutralized. The cash they collected shows up as a price reduction; nothing was gained except a tense true-up call.

How Each Side Should Play It

Sellers:

1. Model the peg before you sign the LOI: insist the mechanism (definition + methodology) is in the LOI, not left "for the lawyers." An LOI silent on working capital is an invitation to renegotiate the price you thought you'd locked.
2. Run the business normally through closing. Every dollar of receivables you strip out comes back as a price adjustment, with interest in goodwill destroyed.
3. Clean the components early: write off dead inventory and stale AR a year before selling, so the peg is set on honest numbers rather than adjusted against you in diligence.

Buyers (and searchers especially):

1. Let the QoE set the peg: the same workpapers producing adjusted EBITDA produce the monthly NWC schedule; don't accept a round number the broker proposed.
2. Match the peg to your close date's seasonality, or you'll fund the gap from your own acquisition facility on day 30.
3. Specify quality tests (AR aging caps, inventory saleability) so the peg can't be satisfied with junk.

Frequently Asked Questions

What is a net working capital peg?

It's the target level of working capital (typically the trailing twelve-month average of receivables + inventory + prepaids − payables − accruals, excluding cash and debt) that the seller must deliver at closing. Actual NWC above the peg increases the price dollar-for-dollar; below it decreases it.

Why doesn't the seller keep the accounts receivable?

Because the purchase price was set as a multiple of earnings that assume a normally capitalized business. In a standard cash-free, debt-free deal with a peg, receivables and inventory at normal levels convey with the business; the seller keeps cash and pays off debt instead.

How is the peg different for seasonal businesses?

A flat TTM average misprices any business whose working capital swings through the year. Seasonal companies typically negotiate a peg matched to the closing month (same-month prior year, or an agreed seasonal schedule), so neither side wins or loses on calendar timing.

Do small SBA-financed deals have working capital pegs?

Increasingly yes, though smaller Main Street deals sometimes still transact "assets only, inventory extra at cost." For any deal priced on EBITDA or SDE with a balance sheet conveying, assume a peg, and if the other side hasn't raised it, raise it yourself while the leverage is still yours.

Key Takeaways

• The NWC peg makes "cash-free, debt-free" workable: the business must convey with a normal tank of working capital, typically the TTM average.
• The true-up is dollar-for-dollar in both directions, so stripping receivables before closing just converts goodwill into a price reduction.
• The fights are in the definition (deferred revenue, deposits), the seasonality, and the quality tests. Settle all three in the LOI.
• Sellers: run the business normally and clean the balance sheet a year early. Buyers: let the QoE build the schedule.

The peg is one more place where the side that models the deal first controls it. ValueAlpha values the business the way the closing statement eventually will (normalized earnings, market multiples, and the balance-sheet reality underneath), so the number you negotiate is the number that survives the true-up.