Working Capital Adjustments in M&A Transactions

The purchase price you agreed is not the amount you receive. It is adjusted at closing against a target
working capital level — the peg — and the adjustment can move six figures on a lower-middle-market
deal. Sellers spend their negotiating energy on the peg number. The money is in the definition of
what counts as working capital, and that is usually drafted by the buyer's counsel and read by nobody
on the seller's side until the closing statement arrives.

A buyer is paying for a business that can operate on the day after closing. That means it needs a
normal amount of receivables, inventory and payables in it — not a company whose owner collected
aggressively and stopped paying suppliers for sixty days before handing over the keys.

So the parties agree a target — the peg — usually derived from a trailing average of the company's
actual working capital, often twelve months. At closing, actual working capital is measured. Above the
peg, the price goes up. Below it, the price comes down.

The mechanism is symmetrical and reasonable. What is not symmetrical is who drafts the definition.

Working capital is current assets minus current liabilities — the difference measuring a company's
liquidity and short-term financial health, as the
NYU Stern School of Business framework describes it. In a
purchase agreement, "current assets" and "current liabilities" mean whatever the schedule says they
mean.

Accounts receivable, and how they are aged. Are receivables over 90 days included at full value,
discounted, or excluded? On a company with $2M of receivables and a slow-paying customer base, that
single choice can move several hundred thousand dollars.

Deferred revenue. Cash you have already collected for work not yet done. Treated as a current
liability, it reduces working capital — and if the peg was set on a trailing average that included a
different deferred revenue balance, the mismatch is real money. For any business with prepayments,
retainers, or annual contracts, this is the single biggest line in the definition.

Inventory and its reserves. Whether obsolete or slow-moving inventory is written down, and on what
policy. A buyer's accountant applying a stricter reserve than the company ever has will find a
reduction.

What is carved out. Cash, debt, and transaction expenses are normally excluded and handled
separately. Accrued bonuses, PTO liability, deferred taxes and related-party balances are all
negotiable, and each one that lands inside the definition is a reduction.

Almost always the buyer, after closing, from the company's post-closing books — which the buyer now
controls. What the seller gets is a review window, and the length of that window and the dispute
mechanism behind it decide whether the review means anything.

Three things worth negotiating and rarely negotiated: a review period long enough to have an
accountant look at it, a requirement that the closing statement be prepared using the same
accounting principles and methodologies used to calculate the peg, and a named independent accounting
firm to resolve disputes over a defined threshold.

The middle one is the most valuable sentence in the section. Without it, a buyer can compute actual
working capital on a different basis from the one that produced the target — and be entirely within
the agreement.

Hypothetical. Constructed to show the arithmetic.

A $12M sale. The peg is set at $1.6M, derived from a twelve-month trailing average.

At closing, the seller's own calculation shows working capital of $1.68M — an $80,000 payment to
the seller.

The buyer's closing statement shows $1.29M, a $310,000 reduction. A $390,000 swing, and the
underlying business is identical. The difference:

None of these is bad faith. Every one is a defensible accounting position. All three are decided by
the definition and the consistency requirement — both settled months before closing, in a schedule that
looks like housekeeping.

Note what did not cause the problem: the peg. $1.6M was never the issue.

The dispute mechanism is the part of the clause nobody reads and everybody eventually uses.

The clock is short and it is a deadline, not a guideline. A typical objection period runs thirty to
sixty days from delivery of the closing statement. Miss it and the buyer's numbers are usually deemed
final by the terms of the agreement, whatever their merits.

You have to say what you disagree with, line by line. Most agreements require the objection notice
to specify each disputed item and the basis for it. A general objection is frequently ineffective, and
the items you did not dispute are typically treated as agreed.

The independent accountant is an expert, not an arbitrator. Their remit is normally limited to the
disputed line items and bounded by the two parties' own positions — they cannot award more than you
asked for or less than the buyer offered. That makes the objection notice a pricing document as much as
a legal one.

And the cost allocation matters. Many agreements split the accountant's fees in proportion to how
the disputed amounts are resolved, which quietly discourages an overreaching objection.

Model the peg against your own last twelve months before agreeing it, using the definition as
drafted rather than as you understand it. If the two produce different answers, the definition is the
problem.

Insist on the consistency requirement. Same principles and methodologies as were used to set the
target.

Read the carve-outs with your CPA, particularly deferred revenue if your business collects in
advance.

Negotiate the review window and the dispute mechanism, which cost nothing at signing and are
worthless to add later.

This sits alongside
indemnification caps, baskets, and survival periods as one of
the two purchase-agreement provisions that decide what a seller actually receives, and both come after
the letter of intent has already anchored
the headline. The wider sequence is
getting a business ready to sell, and this is
sell-side counsel for Texas founders.

Disclaimer. This publication is provided by Amini & Conant, LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. Should the reader seek further analysis of the subject matter or answers to specific questions about the subject matter, please contact the author at neema@aminiconant.com. This publication is considered advertising under applicable state laws.

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