While most sellers are focused on negotiating valuation multiples and earnout terms, working capital issues are quietly eroding how much cash actually hits a seller’s account at closing. Working capital doesn’t get much attention early on in a business sale process, but it is one of the most common reasons sellers walk away with less value than they expected from their company sale.
Why Your Agreed-Upon Price Isn’t Always Your Final Price
Buyers aren’t just acquiring your revenue and customer relationships. They’re acquiring a business that must continue operating normally the day after closing.
That requires:
- Collectible receivables
- Inventory to support demand
- Prepaid expenses and deposits
- Payables that reflect standard terms
In M&A terms, this is net working capital (NWC), defined as current assets minus current liabilities. Importantly, cash and debt (and equivalents) are almost always excluded from the NWC calculation. Sellers typically retain the cash in the business at closing, and the purchase price is negotiated separately from the working capital delivered.
To protect themselves, buyers establish a target level of net working capital they expect at closing. This target, commonly referred to as the working capital “peg”, is typically based on historical operating levels, often using a trailing average.
Here’s how it impacts business sale economics:
- If working capital at closing matches the target, there is no adjustment
- If it exceeds the target, the seller receives additional proceeds, though this is often contested
- If it falls short, the purchase price is reduced on a dollar-for-dollar basis
This adjustment happens at closing. It is immediate, not deferred, and it directly impacts the cash a seller takes home.
The Trap Sellers Walk Into
Once sellers understand the dollar-for-dollar nature of the adjustment, the instinct is often to “optimize” working capital by converting inventory to cash, accelerating collections, or delaying vendor payments.
In practice, these actions are some of the fastest ways to erode value or destabilize a business sale transaction entirely.
Buyers conduct detailed quality of earnings analyses, often reviewing multiple years of working capital trends. When they see sudden changes in receivables timing, inventory levels, or payables aging leading up to closing, they do not view it as optimization. They view it as distortion.
The buyer response is typically as follows:
- The working capital peg is recalibrated downward
- Deal protections become more conservative
- Adjustments are justified to reflect a “normalized” baseline
And just as importantly, trust erodes.
If a buyer believes a seller has manipulated working capital, they start questioning everything else.
How to Prevent Working Capital Surprises
Avoiding working capital surprises starts well before signing a letter of intent (LOI). Here are some ways we help our clients manage working capital considerations.
1. Define “normal” correctly
This is not always a simple trailing twelve-month average.
- Seasonal businesses have natural fluctuations — inventory builds, receivables cycles, and payables timing can swing significantly depending on when in the year the sale closes. For these businesses, the peg should be based on a seasonally adjusted average or tied to the specific month of closing, rather than a flat trailing average that may not reflect the true operating reality at the time of close.
- High-growth companies often require increasing working capital — as revenue scales, receivables and inventory tend to grow in tandem, which means the trailing average used to set the peg may understate the working capital the business actually needs at closing. Sellers of growing businesses should push for a peg methodology that accounts for this upward trend, rather than one that anchors to a lower historical average.
- Changes in payment terms can shift the baseline
The goal is to define a level that reflects how the business truly operates today, not a distorted snapshot in time.
2. Model the peg before buyers do
Every seller should know, before going to market, whether they are likely to land above or below the target.
If a shortfall is likely sellers can:
- Adjust operations early, or
- Negotiate a peg that better reflects reality
Finding out at closing leaves little room to recover value.
3. Get the right expertise involved early
This is where experienced M&A advisors, like our team at Raincatcher, make a measurable difference.
An experienced advisor can help a seller:
- Model working capital accurately
- Identify methodological issues early
- Negotiate clear, protective language at the LOI stage
Experienced advisors also understand how vague definitions can be used to shift value later, and how to prevent these situations from occurring.
Most importantly, the right advisor will not let you sign an LOI with working capital terms that create downstream risk, because once exclusivity is granted, your leverage to fix those terms drops significantly.
Getting Working Capital Right
Working capital often feels like a technical accounting detail compared to headline valuation.
That is exactly why it is underestimated.
In reality, it can materially change final proceeds and meaningfully impact business sale economics.
Sophisticated sellers treat working capital with the same level of importance as any other major transaction term. They:
- Model multiple scenarios
- Negotiate precise definitions early
- Work with advisors who understand how the mechanics actually play out
This is because in M&A, working capital issues rarely start at closing. They typically take shape much earlier in the process.
Ready to explore your exit options?
Reach out to start a conversation about where your business stands today. The decisions you make before going to market often have the biggest impact on your ultimate outcome.
