The Working Capital Peg: 6 Rules to Stop Losing Money on the Balance Sheet After You Sign

On December 31, 2015, Chicago Bridge & Iron sold its nuclear construction business, Stone & Webster, to Westinghouse for a headline price of zero. Weeks later, Westinghouse delivered its closing statement and used the working capital adjustment to claim roughly $2 billion from the seller. The fight went all the way to the Delaware Supreme Court, which ruled for CB&I in June 2017, but by then Westinghouse had already filed for bankruptcy. A deal with a price of zero turned into a two-billion-dollar dispute because of one clause most founders never read: the working capital peg.

The headline price is what everyone negotiates. The peg is what quietly decides how much of it you actually pay or receive. According to SRS Acquiom's 2020 Claims Insights Report, about 80% of M&A deals include a purchase price adjustment mechanism, and working capital is almost always at its center.

We have bought and built businesses across wine, real estate and hospitality for more than a century, and I have learned to spend as much time on this schedule as on the valuation itself. Here are the six rules we use.

What the working capital peg actually is

When you buy a company "cash-free, debt-free," you are paying for a business that can operate on day one. That requires a normal level of working capital: receivables coming in, inventory on the shelf, suppliers paid on their usual terms.

The peg is the agreed target for that normal level. At closing, you measure actual net working capital (current operating assets minus current operating liabilities) and compare it with the peg:

• Below the peg: the price goes down, dollar for dollar.
• Above the peg: the price goes up, dollar for dollar.

The peg is not an accounting formality; it is a second price negotiation that happens after everyone thinks the price is settled. For a deeper look at how price mechanics fit together, see my article on how to structure an acquisition with earnouts and seller notes.

Rule 1: Set the peg on a trailing average, never on one month-end

The most common mistake is pegging to the latest balance sheet. Working capital moves with the calendar. A winery carries its heaviest inventory after harvest; a retailer builds stock before the holidays; a construction firm swings with project milestones.

Consider an illustrative company whose net working capital averaged $3.0 million over the past twelve months but stood at $2.4 million at its last month-end. Peg it at $2.4 million and the buyer hands the seller $600,000 of value the business will need to rebuild within weeks. Peg it at $3.0 million and the price reflects how the business actually runs.

Use a trailing twelve-month average as the default. If the business is strongly seasonal, consider a peg that varies by closing month.

Rule 2: Define working capital line by line, in writing

"Net working capital" means different things to different accountants. The purchase agreement must say exactly which accounts are in and which are out. Typically:

• In: trade receivables, inventory, prepaid expenses, trade payables, operating accruals.
• Out: cash, financial debt, income taxes, transaction costs, and anything already treated as debt in the price.

The dangerous items are the grey ones: accrued bonuses, deferred revenue, customer deposits, unpaid vacation, overdue payables. Every debt-like item that slips into working capital instead of debt gets counted twice or not at all, and the buyer usually finds out after closing. Attach an illustrative calculation to the agreement, using real historical numbers, so both sides see the definition working before they sign.

Rule 3: Normalize the history before you average it

A trailing average is only as good as the numbers inside it. Before calculating the peg, clean the history:

• Write down obsolete or slow-moving inventory to realistic value.
• Reserve receivables that will not be collected.
• Remove one-off items, such as a single giant order or a supplier dispute that inflated payables for two months.

This is the work of a good quality of earnings review, and it pays for itself. If the historical working capital is inflated by stock nobody will buy, a peg based on it makes you pay for that stock twice: once in the multiple and again in the adjustment. It is one of the warning signs I describe in nine due diligence red flags that should stop a deal.

Rule 4: Lock the accounting principles, and put consistency first

The closing balance sheet must be prepared with the same methods used to set the peg. Otherwise the adjustment measures a change in accounting, not a change in the business.

Write a hierarchy into the agreement: first, the specific policies listed in the schedule; second, the company's past practice applied consistently; only then, GAAP or the relevant local standard. The CB&I case shows why the wording matters. The Delaware Supreme Court held that the working capital true-up could not be used to relitigate whether the seller's historical accounts complied with GAAP, because that was what the representations and indemnities were for, and those had not survived closing. Decide which tool covers which risk, and do not expect the adjustment to do the job of the warranties.

Rule 5: Protect the gap between signing and closing

Between signing and closing a seller can, often without bad intent, move working capital: collect receivables aggressively, delay supplier payments, run inventory down. Every one of those moves changes the closing number.

Three protections help:

• Ordinary-course covenants that require the business to keep collecting, paying and buying as it always has.
• A collar or deadband, for example no adjustment for differences within a small agreed band, so small swings do not trigger a fight.
• An adjustment escrow, a separate holdback sized to the realistic range of the true-up, so the money exists when the final number is agreed.

The best adjustment clause is the one that never needs a lawyer, because both sides agreed in advance what normal looks like. These terms are also worth raising early, before exclusivity, as I explain in the seven terms to negotiate in a letter of intent.

Rule 6: Agree the dispute process before you need it

Even with a good definition, the two sides may disagree on the final number. The agreement should set a clear, short process:

• The buyer delivers a closing statement within a fixed period, commonly 60 to 90 days.
• The seller has a fixed window, often 30 to 45 days, to object in writing, item by item.
• Unresolved items go to an independent accounting firm acting as an expert, limited to the disputed items and to a range between the two positions.

A fixed timetable and an independent accountant turn a potential lawsuit into a technical review measured in weeks, not years. Keep the disputed scope narrow: the accountant should rule on numbers, not on legal claims.

Key Takeaways

• The working capital peg is a second price negotiation; treat it with the same attention as the valuation.
• Base the peg on a normalized trailing twelve-month average, adjusted for seasonality.
• Define every account in or out of working capital, and attach an illustrative calculation using real numbers.
• Clean the history of obsolete stock, doubtful receivables and one-offs before you average it.
• Fix the accounting hierarchy: specific policies, then consistent past practice, then GAAP.
• Protect the signing-to-closing gap with ordinary-course covenants, a collar and an adjustment escrow.
• Agree a short dispute timetable and an independent accountant before the deal closes.

Frequently Asked Questions

How is the working capital peg calculated in an acquisition?

It is usually the average of normalized net working capital over the trailing twelve months before closing. The team first adjusts the monthly balances for one-off items, obsolete inventory and doubtful receivables, then averages them. Seasonal businesses may use a month-specific peg.

Does a buyer want a higher or lower NWC peg?

A buyer wants a higher peg. If actual working capital at closing falls short of the peg, the price is reduced by the shortfall, so a higher target means more protection for the buyer. The seller prefers a lower peg for the same reason.

What does peg mean in working capital?

The peg is the target level of net working capital that buyer and seller agree the business needs to operate normally. It works as a benchmark: the closing balance is compared with it, and the difference adjusts the purchase price.

What happens if working capital is below the peg at closing?

The purchase price is reduced dollar for dollar by the shortfall, unless the difference falls within an agreed collar. The payment is usually taken from an adjustment escrow or paid directly by the seller after the final closing statement is agreed.

Before You Sign the Purchase Agreement

Ask your advisors for the illustrative working capital calculation before you discuss anything else in the purchase agreement. If it does not exist yet, the price is not really agreed. To see how our group thinks about acquisitions and long-term ownership, discover Manzanos Enterprises, a family company founded in 1890 that today sells in more than 75 countries.