The buyer agreed to a debt-free, cash-free valuation, but now their attorneys have inserted a complex net working capital peg into the purchase agreement. How does this working capital target work, and how do we prevent it from becoming a disguised price reduction?

Question

Tyler Smith · Accepted Answer

A debt-free, cash-free transaction does not mean you empty your bank accounts and hand over a hollow corporate shell on closing day. Every business requires a baseline amount of operating capital, such as accounts receivable, inventory, and prepaid expenses minus accounts payable and accrued liabilities, to run day-to-day operations. The net working capital (NWC) peg is the agreed-upon benchmark amount of working capital that must remain in the business at closing.

The dispute arises over where that peg is set. If your closing working capital finishes above the peg, the buyer pays you a dollar-for-dollar upward adjustment. If it falls below the peg, your cash proceeds are slashed post-close via a downward adjustment or escrow clawback. Buyers frequently attempt to inflate the target peg by using a trailing twelve-month average during high-growth periods or by excluding legitimate short-term operational liabilities.

To defend your purchase price, take control of the working capital modeling early in diligence. Establish a clear definition of current assets and liabilities, explicitly excluding cash, funded indebtedness, and transaction-related expenses. Normalize the historical data to eliminate seasonal distortions or abnormal supply chain build-ups. If your business is growing rapidly, argue for a shorter measurement window, such as the trailing three or six months, rather than an older twelve-month average that depresses historical working capital requirements. Finally, establish a reasonable collar around the peg so minor post-close balance sheet adjustments do not trigger immediate clawbacks.