The working capital peg is a second price negotiation.

The price you shook hands on is not the price you receive. Your buyer prices the business assuming a normal amount of working capital travels with it. A target gets fixed, and the price moves dollar for dollar against it. Set that target too high and you have taken a price cut that never appears in the price.

What is a working capital peg, and how does it change my price?

A working capital peg is an agreed dollar target for the net current assets the business carries on the closing date. Working capital here means what the agreement says it means: receivables plus inventory plus prepaid items, minus payables and accrued liabilities. Deliver more than the peg and the price rises. Deliver less and it falls.

The purchase agreement defines the target and the formula, an attached worksheet shows it on real numbers, and you deliver an estimated closing statement before closing. After closing the parties recompute and settle the difference in cash or against a holdback.

Read the direction of travel. Some drafts cut the price for a shortfall and pay nothing for a surplus. A one-way adjustment is a drafting choice, not a market term. Make it two-way.

Now the data, and its limits. Published studies report adjustment mechanisms in more than nine of ten private-target deals sampled, with working capital the dominant metric and a dedicated adjustment escrow in most of them. Those samples come from deals priced in the tens and hundreds of millions of dollars, many sponsor-backed. A separate adjustment escrow is a habit of that market, uncommon below it, where the exposure rides inside one indemnity holdback or a seller note. Smaller deals also skip the peg more often, with you keeping the receivables and clearing the payables. Price that option first.

Studies: ABA Private Target Mergers and Acquisitions Deal Points Study (2023 and 2025 editions); SRS Acquiom M&A Deal Terms and Working Capital PPA Studies. Both samples are middle-market or larger.

How is the working capital target actually derived?

Three derivations dominate a working capital target: a trailing twelve-month average of month-end balance sheets, an average across a defined operating cycle, and a figure computed from the cash conversion cycle. Each method produces a different number from the same company. Whoever picks the method and the months picks part of your price.

The trailing average is the default, defensible only if twelve months is a full cycle and no month inside it is abnormal. A cycle average sets the window to the operating cycle, or attaches monthly targets so the peg moves with the season. A cash-conversion-cycle build applies days sales outstanding, plus days inventory, minus days payable, to revenue: clean on paper, dangerous in practice, because the buyer will assume best-quarter collections and worst-quarter payables.

Seasonality is where sellers quietly lose money. If receivables peak in August and you close in February, an annual average makes you deliver February against a number built partly from August. The fix is matching: peg and measurement at the same point in the cycle.

Distorted months are the second leak: a one-time project receivable, a large prepayment, an inventory build for one order, a pre-sale slowdown in payables. None is a normal month.

A peg is not a fact. It is a choice about which months count.

How does a peg set above what the business carries become a hidden price cut?

A peg above what the business actually carries is a price cut dressed as accounting. Assume a price of eight million, a peg of one million two hundred thousand, and a business that runs nine hundred fifty thousand. You collect seven million seven hundred fifty thousand. That gap was a discount, not a shortfall.

Nothing there is a breach. You agreed to the number, on a settlement statement no one calls a price negotiation.

What does “cash-free, debt-free” mean, and do I keep the cash?

Cash-free, debt-free means the buyer values the operating business, you keep the cash on the balance sheet, and funded debt is paid off at closing out of the proceeds. Cash is excluded from the working capital calculation. Debt is handled by a separate indebtedness definition. Both halves have to be drafted, or the phrase is decoration.

Four things quietly take the cash back: a minimum cash requirement buried in the working capital definition; uncleared checks and deposits in transit, which split book cash from bank cash; restricted cash, which is not yours to sweep; and customer deposits counted as cash while the liability counts against you.

Sweeping cash before closing is an entity-law act, not bookkeeping. Under Delaware’s LLC act, a member must repay an unlawful distribution only if the member knew at the time that it violated the statute, and that exposure ends three years later unless suit is filed first. Corporations sit under other sections, with a longer window against directors. Fraudulent transfer law and your loan covenants sit on top. Time the sweep and document solvency.

Law: 6 Del. C. 18-607 (LLC distributions; knowledge requirement; three-year limit unless suit is filed); 8 Del. C. 170 and 174 for corporations. Check your state of formation.

If your buyer uses SBA-guaranteed financing, the loan is sized and approved before closing under the SBA’s operating procedure. SOP 50 10 8 took effect June 1, 2025 for loans receiving an SBA loan number on or after that date, and the SBA revises the SOP, so confirm the operative version. An approved loan amount will not fund a closing-date true-up.

Which definitions inside the peg move the most money?

Definitions move more money than the formula. The formula is arithmetic both sides can check. The definitions decide which dollars enter the arithmetic, and they are negotiated late, in a schedule, by people who are tired. Every line below has cost sellers real proceeds at closing.

Run the last line. An equipment note has three hundred thousand outstanding, sixty thousand due within twelve months. The payoff letter takes the whole three hundred thousand from your proceeds; if the current portion also sits in current liabilities, you fund sixty thousand of it twice. The exclusion is tied to payoff, so name the loans being retired. The same logic covers accrued interest and closing bonuses.

Accrued paid time off is a real liability in many states, not a bookkeeping fiction. California treats vested vacation as wages payable at the final rate and bars forfeiture, unless a collective bargaining agreement provides otherwise; statutory sick leave is generally not cashed out that way. Do not argue the liability away. Argue consistency: if it sits in the closing statement, it sits in every month of the peg.

Deferred revenue is cash collected for work not yet performed. The buyer performs the work, so the obligation belongs in the calculation. The measure is the negotiation: billed price transfers your margin, cost to fulfill transfers only the obligation. Stated as of August 2026, advance payments also carry federal tax timing rules for accrual-method taxpayers.

Law: Cal. Labor Code 227.3 (vested vacation payable as wages; CBA exception; confirm your own states); 26 U.S.C. 451(c) and Treas. Reg. 1.451-8 (advance payments).

Should GAAP, past practice, or an attached worksheet govern the calculation?

Three standards compete: GAAP, GAAP applied consistently with the target’s past practice, or a fixed calculation set out on a worksheet attached to the purchase agreement. The worksheet is the seller’s friend because it removes judgment. Whichever combination you choose, the agreement must state expressly which one wins when they conflict.

Delaware decisions show why, and they govern only if your agreement chooses Delaware law. In Chicago Bridge, the Supreme Court read the agreement as a whole and treated the true-up as a narrow remedy for measuring working capital changes between signing and closing, not a license to press financial statement representation claims through the independent auditor. In Golden Rule, Chancery enforced the hierarchy the parties wrote and required the named revenue standard to be applied correctly, against the company’s own consistent misapplication. In Northern Data, the court construed an express hierarchy putting GAAP first and used the attached illustrative statement to choose among permitted GAAP options. None announced a default rule for a silent agreement; all three enforced the words on the page.

Cases: Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC (Del. 2017); Golden Rule Financial Corp. v. Shareholder Representative Services LLC (Del. Ch. Jan. 29, 2021), aff’d (Del. Dec. 3, 2021); Northern Data AG v. Riot Platforms, Inc. (Del. Ch. June 2025).

Now the trap. Bad debt and obsolescence reserves are judgment calls, and a GAAP-first hierarchy lets the buyer’s accountants re-estimate them after closing, in their favor, and call it compliance. Worse, many businesses at this size keep cash-basis or tax-basis books. A GAAP-first hierarchy there invites the buyer to construct accruals that never existed and deduct them from your price. That is not a truing-up. It is a conversion, performed once, against you.

If your books are not GAAP, a GAAP-first hierarchy is not neutral. It is a repricing right.

What is the seller’s four-part ask on the peg?

The seller’s ask has four parts: an honest derivation, a closed definition, symmetry, and a controlled process. Ask for all four in writing before the purchase agreement is drafted, while the buyer still wants the deal more than the last dollar. After the first draft circulates, each one becomes a concession you buy.

• Derivation. An averaging window matched to your operating cycle, monthly balance sheets for every month used, and abnormal months normalized in the peg and the closing statement alike.
• Definition. A closed list of accounts by general ledger name, a worksheet showing the calculation on a recent month-end, and a priority rule: worksheet first, then past practice, then GAAP. Fix the reserve methodologies there.
• Symmetry. Every exclusion applied to both sides, a two-way adjustment, and a deadband. A cap on the downward adjustment is worth asking for, but it is granted far less often than a deadband, so treat it as a trade.
• Process. You prepare the estimated closing statement, you get the buyer’s workpapers, you get a real objection window. Buyers usually insist on preparing the final calculation, so what you are buying is a narrow mandate: an expert limited to the disputed line items and to the range between the two positions.

Does the true-up have tax consequences after closing?

Stated as of August 2026: a true-up changes total consideration, and consideration is what your tax reporting is built on. An applicable asset acquisition requires both parties to allocate consideration among asset classes under the residual method, reported on IRS Form 8594. A later increase or decrease requires a supplemental statement in Part III.

Scope first. That form covers asset sales and equity sales treated as asset sales by election. A straight stock sale with no election does not use it; there the true-up adjusts your amount realized. Either way, tell your accountant before the return is filed.

Law: 26 U.S.C. 1060; Treas. Reg. 1.1060-1; IRS Form 8594 and instructions, Part III (supplemental statement). Confirm the current form revision and your state’s treatment at closing.

What should you do in the next thirty days?

Start with arithmetic, not argument. Build the twenty-four month history yourself, before a buyer builds it for you. A seller who arrives at the peg conversation with monthly data and a written derivation is negotiating. A seller who arrives without it is accepting.

• Compute working capital for each of the last twenty-four month-ends on one definition, chart it, and mark the peak, the trough, and your likely closing month.
• Flag every abnormal month, explain the distortion in one sentence, and keep the support.
• Quantify what a carve for aged invoices does to each month, not just the last one, and list related-party balances both directions, restricted cash, customer deposits, deferred revenue, and accrued PTO.
• Pull the amortization schedule for every term loan and identify the current portion, so it can be excluded by name.
• Write your proposed peg and derivation on one page, and hand it to your deal counsel before the letter of intent is signed.

Then negotiate the peg in the letter of intent, alongside the price, with the definition attached. A peg agreed in principle at that stage is a number. A peg first raised in the buyer’s draft purchase agreement is a deduction.