The Working Capital Peg: The Price Issue Owners Miss

Owners spend most of a sale process focused on enterprise value. That is the number in the headlines, the number compared across offers, and the number remembered after closing. It is not the number that arrives in the seller's bank account. Between enterprise value and cash proceeds sits a set of closing adjustments, and the largest and least understood of them is the working capital peg.

For project-based, seasonal, or working-capital-intensive services businesses, the peg can move hundreds of thousands of dollars between the parties. It can also generate a post-closing dispute that outlasts the deal itself. The provision rarely gets the attention it deserves until the first draft of the purchase agreement arrives.

This guide explains how the peg works, where services businesses get into trouble, and how to prepare before buyer diligence starts.

Enterprise Value Is Not Cash Proceeds

The bridge from enterprise value to what the seller actually receives runs through several adjustments:

• Debt and debt-like items. Funded debt, capital leases, deferred payroll taxes, and accrued but unpaid obligations are typically repaid or deducted at closing.
• Cash. Excess cash is usually added to equity value, while the operating cash the business needs stays inside.
• Transaction expenses. Advisory, legal, and banker fees allocated to the seller are deducted.
• The working capital adjustment. The business is expected to close with a normalized level of working capital. The buyer and seller compare actual closing working capital to that expectation and settle the difference.

A $20 million enterprise value offer can produce $14 million or $18 million of proceeds depending on how those items are defined. The peg determines the working capital piece, and it is often the largest single adjustment after debt.

The headline price is set in the letter of intent. The cash outcome is set in the purchase agreement definitions and the closing statement.

What a Normalized Working-Capital Peg Does

The peg is an agreed target for net working capital at closing. Net working capital usually means current operating assets minus current operating liabilities, with non-operating items excluded.

A typical structure looks like this:

| Included in the peg | Excluded from the peg | | --- | --- | | Accounts receivable | Cash and cash equivalents | | Inventory and work in process | Funded debt and capital leases | | Prepaid expenses | Income taxes payable and receivable | | Accounts payable | Transaction-related accruals | | Accrued operating liabilities | Intercompany balances |

The peg itself is usually a normalized average, not the balance on the day the letter of intent was signed. Common approaches include a twelve-month average of month-end balances, a trailing average over a set period, or a specific normalized target agreed by both parties. The goal is to define the level of working capital the business needs to operate normally, so the buyer receives a business funded for ordinary operations and the seller is paid for everything above that level.

Two principles make the peg workable:

1. Consistency. The peg should be calculated the same way as the closing statement. Same accounts, same policies, same treatment of unusual items.
2. Normalization. One-time events, seasonality, and unusual collections or delays should be smoothed so the target reflects the operating reality of the business.

Common Issues in Services Businesses

Services companies have working capital profiles that create predictable disputes. The biggest issues:

• Receivables dominate. There is often no inventory and no cushion. If the business closes with receivables above the peg, the seller wants credit. If collections lag, the buyer wants protection.
• Unbilled work and work in process. Project work performed but not yet invoiced can be a large asset. Whether it counts, and how it is valued, must be defined. The buyer may argue that unbilled work is not collectible until invoiced and accepted.
• Deferred revenue and customer deposits. Deposits for work not yet delivered are a liability. Some buyers and sellers disagree about whether deposits belong in working capital at all, especially when they fund future labor.
• Accrued project costs. Job cost overruns, subcontractor accruals, and warranty reserves are easy to overlook and easy to dispute.
• Accrued payroll and bonuses. Payroll timing is a mechanical difference, but discretionary bonus accruals can be large and unpredictable.
• Prepaid insurance and software. Annual prepayments can swing the working capital balance meaningfully from month to month.

The parties can resolve any of these items in the contract, but only if someone surfaces them before closing. A seller who has never built a working capital schedule is at a disadvantage in that conversation.

Seasonal Swings, Unbilled Work, and Deferred Revenue

Seasonality deserves special attention because it can turn a fair peg into a dispute. A landscape maintenance company in the upper Midwest, for example, may collect most of its cash in the growing season and carry little receivables in winter. A peg built on an annual average is one number. A peg built on the closing month's balance is a very different number, and the timing of closing can shift the adjustment by a large amount.

Three practices reduce this risk:

1. Use a twelve-month average. Averaging the month-end balances smooths seasonality and is reasonably predictable. The alternative, a closing date balance, invites argument about collection timing.
2. Define unbilled work precisely. Specify which costs and margins are included, when they are billable, and how the value is calculated. Vague language invites the buyer to assign zero value at closing and argue about it later.
3. Address deferred revenue directly. Decide whether deposits count as a liability in the peg, whether they offset unbilled receivables, and how the treatment changes if the deposit funds work scheduled after closing.

A growth business adds another complication. If revenue is rising, working capital needs rise with it. A peg based on historical averages may understate the cash the buyer must put into the business on day one. Buyers understand this and will ask about it. Sellers should understand it too, because it affects how the peg should be set.

How the Closing Adjustment Works

The adjustment process follows a standard sequence:

1. The purchase agreement defines the peg. It also defines the accounts included, the accounting policies, and the calculation methodology.
2. The seller prepares an estimated closing statement. This estimate produces the preliminary purchase price paid at closing.
3. A true-up period follows. Typically 60 to 90 days after closing, the buyer prepares a final closing statement with actual balances.
4. The seller reviews and disputes. The agreement gives the seller a defined window to object, with access to the underlying records.
5. An independent accountant resolves disagreements. For unresolved items, a neutral accounting firm decides, and the cost is allocated according to the contract.
6. The difference is settled. The buyer or seller pays the difference, sometimes with interest, within a defined period.

The mechanics matter as much as the number. A seller should confirm these points before signing:

• How is the closing statement prepared, and by whom?
• What records does the seller receive, and how quickly?
• How long is the dispute window, and what is the dispute process?
• Is there a cap on the adjustment in either direction?
• Does the agreement require consistent accounting policies with the historical financials?

A peg without a defined process is an invitation to negotiate twice. The purchase agreement is where the process gets locked down.

Records to Assemble Before Buyer Diligence

The seller who can produce a clean working capital history controls this part of the negotiation. Before diligence starts, assemble:

1. Monthly balance sheets for the last 36 months. Twelve months is the minimum. Thirty-six months shows seasonality and growth.
2. Accounts receivable aging by customer. Include collections history, allowances, and any disputed invoices.
3. Accounts payable aging by vendor. Note payment terms, early payment discounts, and vendor credits.
4. Unbilled work and work-in-process schedules. Job-level detail with costs incurred, estimated margin, and billing status.
5. Deferred revenue and deposit detail. Customer by customer, with contract or project references.
6. Accrual schedules. Payroll, bonuses, vacation, warranties, and project reserves, with the basis for each.
7. A normalization memo. One-time items, unusual collection activity, and accounting policy decisions, explained in plain language.
8. A draft peg calculation. The seller's own view of the normalized average, built from the schedules above.

A draft peg calculation is powerful. It frames the negotiation around the seller's methodology, demonstrates management command of the numbers, and shortens the diligence cycle. Buyers treat prepared sellers differently, and this is one of the clearest places it shows.

Prepare the historical schedules buyers will use to set the peg before an LOI turns into a purchase agreement. Bull Holdings can help you get the records and the normalization analysis ready before diligence begins.

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This article reflects general market observations in the lower middle market advisory space. Owners considering a transaction should consult with a qualified M&A advisor and legal counsel specific to their situation and industry.