What is Working Capital Peg?
Short answer: A working capital peg is the target amount of transaction-defined net working capital assumed in the purchase price. A shortfall normally reduces equity value, while an excess may increase it.
The peg is intended to ensure that the buyer receives an ordinarily funded operating business, not one whose receivables were collected aggressively, inventory depleted or suppliers left unpaid before completion. It is not necessarily the latest balance or a simple annual average. The analysis should reflect seasonality, growth, accounting consistency, business changes and the date on which completion is expected. Transaction working capital may exclude cash, borrowings, tax, exceptional items and other balances assigned elsewhere in the bridge. This distinguishes it from the statutory balance-sheet subtotal and from minimum cash required for daily operations.
How it works
The parties define every included account and calculate comparable historical monthly balances using the same policies expected at completion. They identify seasonality, acquisitions, discontinued products, billing changes, one-offs and overdue balances. A methodology may use an adjusted monthly average, a forecast for the completion month or another evidence-based baseline. The agreement states the peg, calculation formula, cut-off, provisioning policies and dispute process. Common mistakes include averaging inconsistent data, treating growth as automatic justification for a higher peg, ignoring intra-month cash collection patterns, and including an item in both working capital and debt-like adjustments.
Working capital adjustment = delivered transaction-defined net working capital - agreed working capital peg
Example
Comparable month-end working capital for the prior twelve months is 9, 10, 12, 14, 15, 14, 12, 10, 9, 8, 8 and 9. The simple average is 10.8, but the business expects completion in its peak inventory month and has grown volumes by 10 percent. After reviewing inventory turns, receivable days and supplier terms, the parties agree a peg of 12 rather than applying the average mechanically. Completion working capital is 11.3, so a one-for-one mechanism reduces equity value by 0.7. A tax payable is excluded because the agreement already treats it separately.
Why it matters
Sellers use the peg analysis to prevent normal seasonality or growth funding from being mischaracterised as a value deduction. Buyers use it to protect post-close liquidity and avoid immediately funding a depleted operating cycle. Boards assess whether pre-completion cash management remains consistent with ordinary operations. Private-investment teams link the peg to the opening balance sheet, debt draw and first months of cash flow. The most defensible peg is one that both the historical data and business model can explain.
The term has no universal accounting definition. Deferred revenue, customer deposits, factoring, overdue receivables, inventory reserves and bonus accruals can be treated differently by business and agreement. Accounting policies may change after acquisition, but the completion calculation must follow the agreed hierarchy. Tax and legal ownership of balances can affect inclusion. Transaction accountants should reproduce the peg from source data, and counsel should ensure the drafting matches that model.