The buyer is demanding a net working capital target that is significantly higher than our historical average, which would force us to leave a massive amount of cash in the business at close. How do we calculate and negotiate a fair working capital peg that reflects our actual cash conversion cycle rather than their arbitrary formula?

Question

Tyler Smith · Accepted Answer

Negotiating the net working capital target is one of the most common battlegrounds in deal structuring. Buyers often try to use a simple twelve-month average to set the target, but this method can work against you if your business has seasonal fluctuations or if you have recently optimized your cash conversion cycle. If the target is set too high, you will be forced to leave your own cash behind at close to meet that arbitrary peg.

To protect your cash proceeds, you must calculate a working capital target that reflects your actual operational cash needs. Analyze your cash conversion cycle over the last twenty-four months, looking at accounts receivable, inventory, and accounts payable. Use this data to present a working capital peg based on your actual, normalized operating requirements.

To defend your calculation, present the buyer with:
- A detailed breakdown of your monthly working capital fluctuations, demonstrating how seasonality impacts your cash needs.
- Proof of recent operational efficiencies, such as faster billing or automated collections, which have permanently lowered your working capital requirements.
- A clear definition of what is excluded from working capital, ensuring customer deposits and pre-payments are treated as cash rather than working capital assets.

By base-lining the target on real operational data rather than a generic formula, you ensure that you do not leave excess cash on the table at closing.