5 min read · 988 words
At a glance
- A buyer sets a working capital target, the peg, in the letter of intent. Deliver working capital below it at close and the purchase price falls dollar for dollar. We have watched a clean $450,000 come off an owner’s check on a term he never negotiated.
- The peg is usually a trailing-twelve-month average. If your last twelve months are inflated by aged receivables, dead inventory, and stretched payables, the target is set high, and you have to hand back the gap in cash at close.
- We rebuild the working capital number a buyer will use before he sets it, so the peg reflects a business that actually runs on that much cash, in 14 days, with one guarantee: at least 3x the fee in owner-accepted value, in 14 days, or you pay nothing.
A buyer can agree to your price and still cut your check by $450,000 at close, and it happens through a term most owners skim past: the working capital peg. It is not a trick. It is the mechanism that decides how much cash comes out of the business the day it changes hands, and owners who negotiate hard on the multiple and ignore the peg give back real money for no reason. Here is how the peg works, where it bites, and how we set it straight before it is set against you.
What is a working capital peg?
When a buyer signs a letter of intent, the price is quoted “cash-free, debt-free.” That means the seller keeps the cash and pays off the debt, and the business is delivered with a normal level of working capital, enough receivables, inventory, and payables to keep running the day after close. The buyer defines “normal” as a number, the peg, usually the trailing-twelve-month average of net working capital.
At close, the actual working capital in the business is measured and trued up against the peg. Deliver more than the target and the buyer pays you the excess. Deliver less and the purchase price drops by the shortfall, dollar for dollar. The headline number on the deal does not change. The amount that lands in your account does.
Why does the peg cut the check?
Because the trailing-twelve-month average is built from the same books that were never built to decide from. Consider a $25M consumer products manufacturer. Over the prior year, receivables ran high because collections drifted to 50 days, inventory carried dead stock nobody wrote off, and payables were paid early out of habit. The trailing average of net working capital came in around $3.6M, so the buyer pegged the target there.
Then the owner did what felt smart before a sale. He pushed collections, thinned the warehouse, and stretched vendor terms, running actual working capital down to about $3.15M at close. Leaner operations, and a $450,000 hole against the peg. The buyer trued up and took $450,000 off the price. The owner had improved the business and paid for it at the closing table, because the target was set on a bloated year and delivered on a lean day.
The reverse is just as costly in the other direction. An owner who lets working capital balloon into close, cash tied up in receivables and stock, hands the buyer that excess as a below-peg true-up he never gets back unless he saw it coming.
How do you keep the peg from working against you?
You set the number the buyer will use before he sets it, on books that tell the truth about how much cash the business actually needs. That is a short, disciplined run, not an audit:
- Rebuild the trailing-twelve working capital on clean books. Write down dead inventory, reserve uncollectible receivables, and correct the payables timing so the average reflects the real business, not a year of drift.
- Find the true operating level of working capital. Strip the seasonal swings and the one-time distortions and land on the number the business runs on day to day. That is the peg you argue for.
- Stop optimizing working capital in the ninety days before close. Every dollar you squeeze out below the peg is a dollar off your check. Run the business normally and keep the cash where the buyer expects it.
- Model the true-up in dollars before you sign. Know, at signing, what the peg means for your proceeds under a high delivery and a low one, so the number in the LOI is one you can defend.
- Tie the peg to the same numbers you built the price on. If your earnings story and your working capital story come off different books, the buyer prices the gap as risk, and the peg is where he collects.
Do that and the peg becomes a fair settling of accounts instead of a $450,000 surprise. Skip it and you learn the term exists on the day it costs you the most.
What this is really about
The working capital peg is one more place a deal is priced on numbers the owner never controlled. It is the same failure that makes deals die in diligence, that shows up in the EBITDA bridge every owner should build first, and that a buyer counts among the five findings that retrade a deal. It is why the work starts long before the term sheet, when you count backward from your sale date and fix the numbers while there is still time.
The Sellable-Numbers Scan rebuilds the working capital number a buyer will peg you on and dollarizes the true-up before you sign, in 14 days, with a simple guarantee: at least 3x the Scan fee in owner-accepted value, in 14 days, or you pay nothing.
If that is the term in front of you, book a fit call. Thirty minutes, no pitch.
Russell Fette · Decisive Finance · Creator of Financial Rhythms™