A low working capital peg leaves you short at closing

Cash-free and debt-free means the seller keeps the cash and clears the debt. It does not mean the business arrives able to make payroll. The working capital peg decides that. Build it from the seller’s monthly balance sheets, define every line, and confirm the funding with your lender before signing.

What is a working capital peg, and what does it do to a buyer’s cash?

A working capital peg is a dollar target for the net working capital the business must hold on the closing date, normally current assets minus current liabilities, with cash and interest-bearing debt stripped out. Every dollar delivered below the peg is a dollar the buyer funds itself, weeks before any true-up payment arrives.

The mechanic looks simple. The parties fix a target. Someone prepares a closing balance sheet. Come in under it and the price drops by the difference, subject to any collar. It rises only where the agreement provides a two-way adjustment, and downward-only mechanics are common at this size. Many agreements here carry no adjustment at all. That is not protection. It leaves the shortfall with you.

Read it as a cash statement, not a price statement. A price reduction is not a deposit into the operating account. It moves later, to whoever the agreement names. A closing statement due sixty days after closing, then a review period, then a dispute window, puts the money in month two or three at the earliest, and only if nobody disputes it.

Meanwhile the company buys inventory and meets payrolls. Vendors who gave the seller sixty-day terms may want cash on delivery from you. That is where a low peg becomes personal money.

So ask three questions before you argue about size. Who pays it. What secures it, an escrow or, more often at this size, an offset right against a seller note. And whether the money lands in the company’s account or in yours. An adjustment paid to you personally fixes no payroll gap unless you contribute it.

How do you build a working capital peg from the seller’s monthly balance sheets?

Building a working capital peg starts with twelve to twenty-four months of monthly balance sheets pulled from the seller’s accounting system, not from tax returns and not from a broker’s summary. Net working capital is computed at each month end on one definition. The average, the trough, and the likely closing month become the three positions.

Ask for these, in this order:

• Monthly balance sheets and profit and loss statements, twenty-four months.
• Receivables and payables agings as of each month end, not as of today.
• Inventory listing with quantities, cost, and last movement date.
• Deferred revenue and customer deposits, with the work still owed.
• Payroll register and accrued paid time off by employee.
• Accrued sales and payroll taxes.

I build the peg from the monthly balance sheets before I read the price in the letter of intent. I ask for the receivables aging as of each month end rather than a single aging as of today, because a current aging hides what the account looked like in February.

That exercise on a seasonal business, as illustration only:

The average is about $348,000, the trough $195,000, the peak $505,000. Three different deals. Watch also for payables stretched just before the sale process. That is a question, not an accusation. Ask it in writing.

Why does a seasonal business need the peg measured at the closing month, not the annual average?

Seasonal businesses carry wildly different balance sheets across the year, so an annual average produces a target the seller cannot hit at a winter closing and a target that is too low at a summer closing. A peg set at the average of the example above, $348,000, is a $153,000 shortfall if the deal closes in February.

Work it through. The seller delivers $195,000 against a $348,000 target and the price drops $153,000. That looks like a win. The seller’s counsel will answer that the target came from months the business never sees in winter, and will be right. Worse, the reduction arrives after the closing statement process, while payroll arrives on Friday.

Three usable answers exist. Set the target from months that resemble the closing month. Set a fixed target and pair it with a funded credit line. Or step the target by closing month in a schedule. Each moves risk: an average target has you funding now and collecting later; a trough target has you funding the build alone.

The peg equalizes value. It does not create liquidity. Those are two different problems, and the purchase agreement only solves one of them.

Which lines in the working capital definition should a buyer negotiate?

The definition of net working capital decides more money than the target does, because it governs a closing balance sheet built on bookkeeping that was the seller’s. The lines that move real dollars are receivables aging and reserves, inventory obsolescence, accrued paid time off, customer deposits and unearned revenue, and accrued taxes.

Name who prepares the closing statement and by when. Whoever holds the pen sets the starting number.

One qualification runs under that table. Most acquisitions at this size are asset purchases, where you take only the assets conveyed and the liabilities you assume, so the definition must track that list, not the seller’s whole balance sheet. Whether unpaid sales or payroll tax follows the business anyway, and whether accrued vacation is a wage on separation, are state law questions for local counsel.

Here is where this cuts against you. Win a hard receivables haircut in the definition, then set the target from historical months computed without it, and you are asking the seller to fund the same dollar twice. A real double count.

The fix is procedural. Negotiate the definition first. Recompute the historical months under it. Then set the target from those numbers.

Negotiate the definition, rebuild the history under it, then set the number. A target computed on a definition nobody will use at closing is a number waiting to be fought over.

A collar, a band inside which no adjustment happens, shifts small shortfalls to you. Size it to what the operating account can absorb.

What belongs in the accounting principles schedule?

The accounting principles schedule tells whoever prepares the closing balance sheet exactly how to compute each line. Without it, the purchase agreement often says the closing statement must be prepared consistent with the seller’s historical practice and with generally accepted accounting principles, and those instructions conflict the moment that practice was not GAAP.

Assume the conflict is live. Sellers at this size often keep books on a tax or cash basis, so a GAAP reference can describe statements that never existed.

State the hierarchy in the agreement, in order. First the schedule. Then historical practice, where the schedule is silent. Then GAAP, where both are silent. Write it so a stranger reading it in month three cannot reorder it.

Ordering matters. Put GAAP first and the closing statement can be recast under principles the seller never used. In one large transaction, Delaware’s Supreme Court read a post-closing true-up as a narrow, subordinate and cabined remedy aimed at developments between signing and closing, not a license to re-audit the seller’s accounting, because the agreement as a whole pointed that way. The buyer lost. That reading turned on an unusual agreement and on Delaware law, and yours may be governed elsewhere.

Case: Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co. LLC, 166 A.3d 912 (Del. 2017).

Then make it specific. A schedule that says “consistent with past practice” and stops is not a schedule. Name the treatments:

• Reserve percentages by receivable aging bucket, stated as numbers.
• Inventory costing method, and an obsolescence rule stated as a test.
• The paid time off accrual formula, employee by employee.
• Whether unbilled work in progress counts, and how measured.
• Which prepaid items are included, by name.
• That estimation methods cannot change after the sample calculation.
• A sample calculation, attached, using a recent month.

Then define the dispute path. Neutral accountant mechanics are routine in larger transactions and often missing at this size. Expect to ask. Say the accountant resolves only the disputed items, picks a value within the range of the parties’ positions, and applies the schedule rather than its own preferred accounting. Say how the cost is split.

How does SBA 7(a) financing change the working capital conversation?

SBA 7(a) financing changes the working capital conversation because the loan is sized and approved against a stated structure before closing, and working capital sits inside that structure. Working capital is an eligible use of 7(a) proceeds. It is also part of total project cost, the base for the required equity injection.

Law: 13 CFR 120.120; 13 CFR 120.130; 13 CFR 120.202.

Stated as of September 2026: SOP 50 10 8 took effect June 1, 2025, and SOP 50 10 8.1, published August 14, 2026, takes effect October 1, 2026 for applications receiving an SBA loan number on or after that date. For a complete change of ownership the SOP sets a minimum equity injection of ten percent of total project cost, which includes the working capital in the loan request plus closing and soft costs. Under 50 10 8.1 the limited sources, full standby seller debt among them, are capped in the aggregate at half that injection. Partial changes of ownership run on different rules, and none of this is permanent. Confirm the edition in force with your lender in writing: the version that governs is the one in effect when your loan number issues.

SBA: SOP 50 10 8 (effective June 1, 2025); SOP 50 10 8.1 (effective October 1, 2026), Information Notice 5000-880695. Stated as of September 2026.

Do the arithmetic. Add $150,000 of working capital to the loan and you add $150,000 to total project cost and roughly $15,000 to the required injection, and with limited sources capped at half, a standby seller note cannot cover all of that increase. The guaranty fee moves with loan size too. Size working capital early, while the injection is still being assembled.

Two structural limits matter before you negotiate a peg. The statute caps the gross 7(a) loan, so price plus working capital plus fees past the cap forces a different structure, not a bigger loan. And changing the loan amount after approval is a post-approval action on SBA Form 2237, generally carrying an additional guaranty fee on the increase, subject to the lender’s authority and the SOP in force. Neither the lender nor the SBA owes you a decision on your schedule.

Law: 15 U.S.C. 636(a)(3). Form: SBA Form 2237, 7(a) Loan Post Approval Action Checklist.

Ask your lender two questions in writing, early. Whether the loan can carry a stated working capital line item. And whether a credit line can sit alongside the term loan, including the SBA’s 7(a) Working Capital Pilot, a temporary pilot lenders have processed since August 1, 2024 and scheduled to run through July 31, 2027 unless SBA extends it.

SBA: 7(a) Working Capital Pilot program, sba.gov. Stated as of September 2026.

What should you do before you sign the letter of intent?

Before signing the letter of intent, a buyer should convert the phrase “cash-free, debt-free” into three concrete items: a stated method for setting the working capital target, a stated definition of net working capital, and the lender’s stated answer on how the working capital piece gets funded. Each is harder to get later.

• Request the statements and schedules listed above, before you sign.
• Compute net working capital for every month on one definition, and write down the average, the trough, the peak, and the expected closing month.
• Put the method in the letter of intent, not the number.
• List the lines you will negotiate, and confirm the definition reaches only the assets you buy and the liabilities you assume.
• Recompute the history under your definition before you propose a target.
• Ask the lender, in writing, about the working capital line item, its effect on your injection, and a credit line alongside the term loan.
• Ask which SOP edition will govern your file.
• Confirm whether the adjustment runs both ways, where the dollars land, and what secures them: escrow, offset against a seller note, or nothing.

Do those eight things and the peg stops being the last term nobody read. It becomes the term that decides whether the business can pay its people in week one.