Working Capital Adjustment in Business Sales: The Provision That Surprises Sellers at Closing

You negotiated hard. You got the price you wanted. You signed the LOI, survived due diligence, and made it through the purchase agreement negotiations. Closing day arrives.

Then the final settlement statement shows a working capital adjustment of -$285K.

The purchase price is still the same number on the front page. But the amount you are actually receiving just dropped by $285K.

This happens more often than it should, and almost always because sellers did not understand the working capital provision when they signed the LOI.

A working capital adjustment in a business sale is a mechanism that adjusts the actual proceeds the seller receives at closing based on the amount of working capital in the business at close compared to an agreed-upon target. If working capital at close is below the target, the seller receives less. If it is above the target, the seller receives more. The target is negotiated, usually before the LOI is signed, and the final adjustment can be significant in either direction.

Key Takeaways

• Working capital adjustments are standard in most lower middle market transactions above $5M in enterprise value.
• The working capital target should reflect the historical normalized working capital of the business, not an inflated figure the buyer proposes.
• Adjustments of $100K-$500K at closing are common. Understanding the mechanism and negotiating the target carefully can preserve or add to your proceeds.
• A Quality of Earnings report establishes a defensible historical working capital baseline, another reason to commission it before going to market.
• The working capital peg is often overlooked in LOI negotiations and then becomes a contentious point at closing.

What Working Capital Is and Why It Matters in M&A

Working capital is current assets minus current liabilities, a measure of the short-term liquidity and operational resources of the business. In the context of a business sale, working capital represents the resources the buyer needs to operate the business on a day-to-day basis after the transaction closes.

Typical components of working capital in a lower middle market business:

Current assets: accounts receivable, inventory, prepaid expenses, cash held in the business

Current liabilities: accounts payable, accrued liabilities, deferred revenue, short-term obligations

The reason working capital matters in a sale: when a buyer acquires a business, they are acquiring an operating entity that needs a certain amount of working capital to function normally. If the seller drains the business’s working capital before closing, collecting receivables aggressively, delaying payables, drawing down inventory, the buyer acquires a business that is technically intact but immediately resource-constrained.

The working capital adjustment prevents this by ensuring the business arrives at closing with a normalized amount of operational resources intact.

How the Peg Works

The “working capital peg” is the agreed-upon target that actual working capital at close is compared against.

Setting the target. The target is typically negotiated in the LOI and is usually set at the historical average working capital of the business over the trailing 12 months. Buyers sometimes propose targets that are higher than historical averages, a number that looks reasonable on the surface but practically means the seller needs to deliver more working capital than the business normally carries, effectively reducing proceeds.

The adjustment. At closing, the business’s actual working capital is calculated. If actual working capital exceeds the target by $100K, the seller receives an additional $100K. If actual working capital falls below the target by $200K, the seller’s proceeds are reduced by $200K.

Post-closing true-up. Most purchase agreements include a post-closing true-up process, a specified period (typically 60-90 days after close) during which the buyer and seller finalize the actual working capital calculation using the business’s closing books. This creates a window for disputes if the parties have different views on how certain items should be classified.

Why Disputes Happen

Working capital disputes typically arise from classification disagreements: which items are included in the calculation and how they are valued.

Common dispute areas:

Deferred revenue, whether it counts as a working capital liability and how it is measured

Accrued liabilities, whether all accruals are included and how timing affects the calculation

Inventory valuation, whether obsolete or slow-moving inventory is included at book value

Accounts receivable, whether aged receivables are included at face value or discounted

The resolution mechanism matters. Most purchase agreements specify an independent accountant process for resolving working capital disputes, the parties submit their respective calculations and an independent firm makes a binding determination. Make sure the purchase agreement specifies this mechanism and the timeline, rather than leaving resolution to negotiation or litigation.

How to Protect Yourself

Negotiate the target carefully. The working capital target should be based on the trailing 12-month average of actual business operations, not a conceptual “normalized” number that happens to be higher. Use historical financial data to support your proposed target and push back on buyer proposals that exceed historical averages.

Commission a sell-side QoE. A Quality of Earnings report establishes the historical working capital baseline with documentation, making the target negotiation data-driven rather than adversarial.

Understand what is in and out. Make sure the definition of working capital in the purchase agreement is specific and agreed. Every item included or excluded from the calculation affects the final adjustment.

Monitor working capital through closing. Do not make unusual working capital decisions in the 60-90 days before closing, no aggressive receivables collection, no unusual payables timing, no inventory drawdown. Unusual working capital movements before close are exactly what the adjustment mechanism is designed to protect against, and they create dispute risk.

Frequently Asked Questions

What is a working capital adjustment in a business sale?

A mechanism that adjusts the seller’s actual proceeds at closing based on the business’s working capital (current assets minus current liabilities) at close relative to an agreed-upon target. Sellers receive more if working capital exceeds the target and less if it falls below.

What is a typical working capital target in a lower middle market acquisition?

Typically the trailing 12-month average working capital of the business. Buyers sometimes propose targets above historical averages, sellers should push back and anchor the target to documented historical data.

How much can working capital adjustments affect my proceeds?

Commonly $100K-$500K in either direction for lower middle market transactions. The specific amount depends on the target, the business’s working capital patterns, and any changes that occur between signing and closing.

How are working capital disputes resolved?

Most purchase agreements specify an independent accountant process, both parties submit their calculations, and an independent firm makes a binding determination. Make sure this mechanism is included in the purchase agreement with clear timelines.

Daniel Askew is the Founder and CEO of Icon Business Advisors, a Nashville, Tennessee M&A advisory firm.

[Talk to an M&A Advisor], Working capital provisions are one of many deal points worth understanding before you sign.

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