A working capital peg is the target level of day-to-day operating money the seller agrees to leave in the business. If working capital at closing lands above the peg, your price usually goes up, and if it lands below, your price usually goes down, dollar for dollar. Working capital here means what customers owe the business, plus inventory and prepaid costs, minus the bills it owes soon. This primer is for buyers who see a "working capital adjustment" in a letter of intent (LOI) and want to know what it does to their cash after closing.
The short answer
- Working capital is generally operating current assets (receivables, inventory, prepaid expenses) minus operating current liabilities (payables, accrued expenses). It leaves out cash and interest-bearing debt.
- The peg is the agreed target. If working capital at closing is above it, the price usually goes up. If it is below, the price usually goes down. The agreement sets the exact mechanics.
- A true-up is the settlement a few months after closing, once the final closing numbers exist. The purchase agreement sets who prepares them, the deadlines and how disputes are decided.
- A peg set too low can leave you funding the business out of pocket in month one, just as debt service starts.
- Insurance shows up on the list: prepaid premiums, unpaid or financed premiums, audit balances and accrued claim costs all need a home in the definition.
What is net working capital, in plain words?
Think of it as the cash cycle of the business. Customers owe it money (receivables), it holds stock to sell (inventory) and it has paid for some things in advance (prepaid expenses). Against that it owes suppliers, payroll and other bills (payables and accrued expenses). In deal practice, net working capital is generally operating current assets minus operating current liabilities, excluding cash and interest-bearing debt. The edges are negotiated: how to treat deferred revenue, customer deposits and accrued taxes differs from deal to deal.
Many deals are priced cash-free and debt-free. The seller keeps the cash and pays off the debt at closing, and in return delivers a normal level of working capital. Many small asset purchases reach the same place more simply, by listing cash and certain debts as excluded from what the buyer is buying.
Not every small deal uses a peg. Some price inventory from a count at closing and leave receivables and payables with the seller. Ask deal counsel which approach your agreement takes, because the cash you need on day one differs.
| Item | Usually counted? | Why it gets argued |
|---|---|---|
| Receivables (what customers owe) | Yes, as an asset | Are old balances really collectible, and who keeps cash from pre-closing sales? |
| Inventory | Yes, as an asset | Slow or obsolete stock carried at full cost |
| Prepaid expenses (including prepaid insurance) | Often yes | A prepaid item only helps you if its benefit actually transfers to your company |
| Payables and accrued expenses | Yes, as a liability | A seller can stretch payables and collect receivables early to pull cash out before closing |
| Deferred revenue and customer deposits | Negotiated | The cash is gone but you still owe the work |
| Cash | No in cash-free deals | The seller keeps it |
| Loans, credit lines, equipment financing | No, treated as debt | Usually paid off from the seller's proceeds at closing |
How is the peg set, and what is the true-up?
The peg is the target amount of working capital the buyer expects to receive. It is usually set from an average of month-end working capital over the prior 6 to 12 months, cleaned of one-time items. One sell-side advisory firm notes that longer periods smooth out seasonality. A fast-growing business may need more working capital after closing than a 12-month average shows. A rough peg is often estimated at the LOI stage. LOIs are usually drafted so that term is non-binding, but whether it binds depends on the wording, so ask counsel. The final peg is set during diligence and written into the purchase agreement.
- LOI: a preliminary peg or a promise to set one.
- Diligence: the buyer's accountant or a quality of earnings provider (an accounting firm that tests the seller's numbers) rebuilds monthly working capital and tests the average.
- Purchase agreement: defines which accounts count, the accounting method and often attaches a sample calculation.
- Closing: working capital is estimated and the price is adjusted by the gap from the peg.
- After closing: a final statement is prepared and the difference is settled in a true-up (a post-closing price adjustment). Timing varies by deal, often a few months after closing, and the agreement controls.
- Disputes: unresolved disagreements usually go to an independent accounting firm whose decision is binding.
Who prepares the final statement, how long each side has and what the accountant may decide are all drafting points for deal counsel. See what a business purchase agreement covers.
Where do buyers and sellers usually disagree?
Most peg fights are not about arithmetic. They are about what was counted and how. Use the table as a list of questions for your accountant.
| Issue | Why it matters | Question to ask |
|---|---|---|
| Seasonality | Working capital swings between busy and slow months, so closing in a trough or a peak distorts the result | Was the peg built from every month, and does the closing month fit the pattern? |
| Growth or decline | A growing business needs more working capital than last year's average shows | Does the peg reflect what the business needs to run after closing? |
| One-time items | A big unusual receivable, payable or prepayment can skew the average | Which months were normalized, and why? |
| Accounting method | Different reserves or cut-off rules change the same balance sheet | Does the contract use the same method for the peg and the closing statement? |
| Receivable and inventory quality | Old receivables and stale stock inflate the number | Are reserves for bad debt and obsolete stock built in? |
| Deferred revenue, deposits, accrued taxes | They are real obligations but may sit outside "current liabilities" | Are they in the definition, treated as debt or excluded? |
The definition in the contract matters as much as the number, so a sample calculation attached to the agreement is worth asking for. For how the peg connects to price and earnings, see what a quality of earnings report examines and how small businesses are valued.
What does a peg adjustment look like in dollars?
A hypothetical example. A buyer agrees to pay $2,000,000 for a seasonal services business whose busy months come after closing, cash-free and debt-free. The twelve month-end working capital figures average $400,000, so the peg is $400,000. Closing falls at the end of a slow month, and the seller's closing estimate is $340,000. After closing, the buyer's accountant prepares the final statement, which shows $325,000.
| Step | Working capital | Effect on price |
|---|---|---|
| Peg in the agreement | $400,000 | Starting price $2,000,000 |
| Estimate at closing | $340,000 | $60,000 below the peg, so $1,940,000 is paid at closing |
| Final statement after closing | $325,000 | $15,000 further below, so the seller owes the buyer $15,000 in the true-up |
| Net result | $1,925,000 for a business delivered $75,000 under its normal level |
Now change one thing. If the peg had been set at $300,000, the lowest month, the same $340,000 estimate would have raised the price by $40,000 even though the business arrived below its average need. The buyer would pay more and still have to fund the cash needs of the busy months ahead. The peg, not the price, decided who carried the seasonal swing.
Why does the peg matter to your cash flow after closing?
The business needs a normal level of working capital to pay staff and suppliers before customers pay it. If the seller delivers less, you fund the gap with your own cash or a line of credit, in the same month your debt service begins. For a search fund CEO that can look like an unplanned capital call to investors. For a buyer using a loan from the U.S. Small Business Administration (SBA), the lender has underwritten a specific cash flow, and a short working capital position can strain it.
Do not plan on the true-up to fix the first few months. It arrives after closing, and a payment owed to you is only as good as the agreement's collection terms and the seller's willingness to pay. Part of the price is often kept back or placed in escrow (held by a neutral third party) for a period, which can give the true-up some security. See seller financing and earnouts explained.
One SBA point is worth knowing. For 7(a) change of ownership loans, the SBA rulebook (Standard Operating Procedure (SOP) 50 10 8.1) says a working capital true-up in the purchase agreement is not treated as a buyer rebate, and cash you receive from it may be kept to support working capital. Ask your lender how a shortfall at closing, and any true-up payment, fit its budget of where the deal money comes from and goes (its sources and uses). Budgeting guidance is in how much cash you need to buy a business.
Where does insurance show up in the peg?
Insurance items are easy to forget because they sit in small balance sheet lines. Each one needs a deliberate home: counted in working capital, treated as debt, or left with the seller. Your accountant and deal counsel decide the treatment. Your broker can supply the facts.
| Item | What to know | Question to settle |
|---|---|---|
| Prepaid premiums | In an asset deal you generally cannot take over the seller's policy, because standard policy conditions bar transferring rights without the insurer's written consent. In a stock deal the policy generally stays with the company, subject to any change in control terms, so the prepaid amount generally keeps its value | Will you actually get the benefit of anything counted as prepaid? |
| Return premium on cancelled policies | If the seller cancels after an asset sale, the refund goes to the first named insured (the company listed first on the policy, usually the seller), after any premium finance balance, and may be reduced if the policy is cancelled mid-term | Who keeps the refund? |
| Unpaid or financed premiums | Financed premium is a loan, and unpaid installments are a bill | Is it paid off at closing, or treated as debt? |
| Premium audit balances | Workers' compensation and often general liability premiums start as estimates, with the final premium set after the policy ends. The insurer can audit for up to three years afterward under workers' compensation policy wording. In a stock deal the balance usually stays with the company. In an asset deal it is normally the seller's, and the contract decides who bears it. | Who bears a post-closing audit bill for pre-closing payroll? |
| Accrued claim costs and deductibles | Deductibles or retentions still owed on open claims, and claim costs the seller handled directly, are real obligations. Claims not yet reported are an estimate, not a bill, and are often handled by an indemnity (the seller's promise to cover a loss) or a holdback (part of the price kept back) | Are they counted as liabilities, or covered by a specific indemnity? Ask counsel |
Details are in workers' comp payroll estimates and audit bills, the glossary entry on a premium audit and insurance in your quality of earnings review.
What should you ask before you agree to a peg?
- Your accountant: Did you rebuild monthly working capital from the ledger, and which months did you normalize? Does the sample calculation use the same method as the peg?
- Deal counsel: Who prepares the final statement, who decides disputes and is any part of the price held back to secure the true-up?
- Your lender: How does a shortfall at closing fit the lender's sources and uses (its budget of where the deal money comes from and goes), and is working capital cash expected to stay in the business?
- Your insurance broker: What premiums are prepaid, financed or unpaid? Which policies end at closing, and what audits are open?
- The seller: What does working capital look like in the busiest and slowest month, and what changed in how you collect and pay since last year?
For the full pre-closing insurance list see the insurance checklist for buying a business. A quote from a carrier is not bound coverage, so confirm the policies that must be in force on closing day before the money moves. See what happens on closing day.
Keep reading
- What Is a Quality of Earnings Report?
- Seller Financing and Earnouts: What Buyers Need to Know
- What a Business Purchase Agreement Covers
- How Much Cash Do You Need to Buy a Business?
- What Happens on Closing Day When You Buy a Business
- All guides for new business owners
Frequently asked questions
What is a normal working capital peg?
There is no standard number. The peg comes from the business's own history, usually an average of month-end working capital over six to twelve months, adjusted for one-time items and seasonality. Your accountant and counsel set it for your deal.
Is a higher peg better for me as the buyer?
A higher peg generally favors the buyer, because the seller must deliver more working capital or accept a price cut. A lower peg generally favors the seller. A peg far above what the business normally needs can stall a deal, so the goal is a number that matches normal operation. Your accountant can test it against the monthly figures.
Is cash part of working capital in a business purchase?
In most deal definitions, no. Net working capital generally leaves out cash and interest-bearing debt, and many deals are priced cash-free and debt-free so the seller keeps the cash and pays off the debt. Your purchase agreement defines it.
What happens if the seller and I disagree on the final working capital number?
Purchase agreements usually send unresolved disagreements to an independent accounting firm whose decision is binding. Who prepares the statement, the deadlines and the process are set in the agreement, so have counsel review them before you sign.
Does an SBA loan change how a working capital adjustment works?
The SBA's rulebook for 7(a) change of ownership loans says a working capital true-up is not treated as a buyer rebate, and cash received may be kept for working capital. Your lender applies the rules to your file, so ask how it fits their sources and uses of deal money.
Can the peg change between the letter of intent and closing?
Yes. A preliminary peg in an LOI is usually an estimate and is typically drafted as non-binding, though how an LOI binds depends on its wording. The final peg is set during diligence and written into the purchase agreement, so treat the early number as a rough estimate and ask counsel how your LOI is drafted.
References
- Pease Bell: Net Working Capital Peg in M&A, How It Moves the Purchase Price (October 15, 2026)
- Morgan & Westfield: Net Working Capital (NWC) for M&A, a Complete Guide (sell-side advisory firm, 2026)
- U.S. Small Business Administration: SOP 50 10 8.1, Appendix 15, change of ownership (effective October 1, 2026)
- NCCI: Workers Compensation and Employers Liability Insurance Policy, WC 00 00 00 C (final premium, audit and transfer conditions; carrier-hosted copy)
- ISO IL 00 17 11 98, Common Policy Conditions (transfer of rights and duties; carrier copy)
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This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.