How do we manage our working capital and balance sheet cycles during the twelve months before an LOI so buyers cannot manipulate the net working capital target against us at closing?

Question

Tyler Smith · Accepted Answer

Net working capital is where unwary sellers give back millions of dollars in final transaction adjustments. In every standard purchase agreement, the purchase price assumes the seller leaves a normal level of working capital in the business at closing. If your trailing twelve-month average working capital is artificially inflated, the buyer sets a higher peg, forcing you to leave behind excess cash or receivables without compensation.

To prevent this, you must run a disciplined, predictable balance sheet for at least twelve to eighteen months before signing a Letter of Intent. The net working capital peg is calculated using historical averages of current assets minus current liabilities, excluding cash and interest-bearing debt. When operational leaders let inventory sit idle, fail to collect accounts receivable aggressively, or prepay vendor expenses inconsistently, the baseline becomes distorted.

Use your weekly Scorecard to stabilize working capital components. Set strict targets for accounts receivable aging, days inventory on hand, and accounts payable terms. Do not engage in irregular behavior leading up to the sale, such as delaying vendor payments to hoard cash or running deep-discount promotions to liquidate inventory. Quality of earnings auditors review monthly balance sheets and will spot these anomalies immediately.

Work with your sell-side M&A advisor to establish your own working capital methodology before the buyer proposes theirs. By demonstrating consistent, stable working capital management week in and week out, you defend your peg calculation and ensure every dollar of earned value stays in your pocket at closing.