Working-capital target

A working-capital target (or "net working-capital peg") is a negotiated benchmark for the amount of net working capital (NWC) the seller must leave in the business at closing. Because most private deals are priced on a "cash-free, debt-free" basis, the buyer needs the company delivered with a normal level of operating working capital — enough to run day-to-day without an immediate cash injection. The target defines "normal," and any deviation from it adjusts the price dollar for dollar.

Why it exists

In a cash-free, debt-free deal, the seller keeps the company's cash and pays off its debt, and the enterprise value is fixed independently of those. But working capital — receivables and inventory minus payables and accruals — is part of the operating engine, not surplus cash. Without a peg, a seller could strip working capital before closing (aggressively collecting receivables, delaying payables, running down inventory), handing the buyer a business that needs cash on day one. The target prevents that: it locks in the working-capital level baked into the price.

How the adjustment works

The mechanism runs in two steps:

1. At closing (estimate). The parties estimate closing-date NWC and adjust the price up or down versus the target. If estimated NWC is above target, the buyer pays the seller the excess (the seller is leaving more behind); if below, the price is reduced.
2. Post-closing (true-up). After closing, actual NWC is finalized (often within 60–90 days), and a true-up payment settles the difference between estimate and actual — frequently secured by a small escrow or holdback dedicated to the adjustment.

Price adjustment = Actual NWC at close − Working-capital target

Setting the target

The target is usually a trailing-12-month average of NWC, which smooths out seasonality (a business that builds inventory before a busy season would otherwise look mis-pegged depending on the closing date). Determining a fair peg is one of the most important — and contentious — outputs of financial diligence: a quality-of-earnings (QoE) analysis examines the historical NWC trend, normalizes for one-offs, and recommends the peg. Buyers push the peg up (more capital delivered for the same price); sellers push it down.

A frequent source of disputes

Working-capital adjustments are a leading cause of post-closing disputes, because they hinge on judgment-heavy questions: which accounts count as "working capital" versus "debt-like," what reserves are adequate (bad-debt, obsolete inventory), and whether the same accounting policies used to set the target were used to compute the closing figure. Well-drafted agreements specify the exact definition, the accounting principles ("consistent with past practice"), and a dispute-resolution path (typically referral to an independent accountant) to contain these fights.