The buyer wants to use a simple cash-free, debt-free net working capital peg based on our last twelve months, but our transition to automated subscriptions has permanently altered our deferred revenue. How do we adjust the working capital peg to reflect this structural shift?

Question

Tyler Smith · Accepted Answer

Setting the net working capital peg is one of the most contentious parts of a transaction. If you have recently transitioned to an automated subscription model with upfront cash payments, a traditional twelve-month average working capital peg will penalize you. It will force you to leave a massive amount of cash in the business at close to cover deferred revenue that you have already collected but not yet fully recognized as earned.

To prevent this cash grab, you must negotiate a customized working capital mechanism. First, argue that deferred revenue should be excluded from the definition of net working capital for the purposes of the peg. Since your automated workflows and subscription model require minimal physical inventory or variable costs to deliver, the actual cash cost to fulfill these services is incredibly low.

Second, propose a shorter look-back window, such as the trailing three months, to set the working capital peg. This shorter window accurately reflects your current, highly efficient cash-upfront operating model rather than historical periods when your working capital needs were higher.

Present a detailed cash flow analysis during the due diligence phase to show the buyer exactly how your automated billing reduces the cash required to run the daily operations. By adjusting the peg window and excluding deferred revenue, you ensure that the cash you have earned through your operational efficiency remains in your pocket at closing.