We received an LOI with a standard cash-free, debt-free clause and a target working capital peg, but we are confused about how the working capital adjustment can effectively lower our purchase price at closing. How does this mechanism work?

Question

Tyler Smith · Accepted Answer

A cash-free, debt-free transaction means the seller keeps the cash and pays off all debt at close. However, the buyer is acquiring an operational business, which means they require a normal level of Net Working Capital (NWC) to fund daily payroll, pay suppliers, and collect receivables without injecting fresh cash on day one.

The working capital adjustment mechanism works against a peg established during diligence:
- If actual NWC at closing is higher than the peg, the buyer pays you an upward purchase price adjustment.
- If actual NWC at closing is lower than the peg, you suffer a dollar-for-dollar reduction in cash proceeds, often deducted from your escrow or closing wire.

Buyers attempt to weaponize this mechanism by pushing for an inflated target peg. If they use a peak seasonal month instead of a trailing twelve-month average, or if they classify standard operating accruals as current liabilities while excluding valid receivables, they artificially set the hurdle too high.

To defend your purchase price, define Net Working Capital precisely in the definitive agreement. Exclude non-operating assets, strip out transaction-related accruals, and agree on a consistent trailing twelve-month methodology that accounts for seasonal spikes. Establish a mutual collar, such as plus or minus fifty thousand dollars, within which no adjustment occurs. Never leave the working capital methodology open to post-closing interpretation.