Glossary
Net Working Capital Peg
A net working capital peg is the normalized level of working capital that a buyer and seller agree a business needs to operate after closing, set as a target in the purchase agreement so the final price adjusts for any excess or shortfall delivered at close. It is one of the most consequential numbers in any deal, and our transaction advisory practice sets it as part of every Quality of Earnings report.
Why deals need a peg at all
Most transactions are done on a cash-free, debt-free basis: the seller keeps the cash and pays off the debt at closing, and the buyer pays for the operating business. But the business still needs working capital, the receivables, inventory, and payables required to keep running, on day one. Without a peg, a seller could collect every receivable and stop paying suppliers right before closing, handing the buyer an empty shell that needs an immediate cash injection. The peg prevents that by fixing how much working capital must be left in the business.
How the peg is set
Setting the peg is a normalization exercise, much like EBITDA normalization. We look at the components of working capital over a trailing period, usually twelve months, and strip out the distortions:
- Seasonality, by using an average rather than a single month-end.
- Non-operating and related-party balances that will not transfer.
- One-time spikes in receivables, inventory, or payables.
- Items that belong in the cash-free, debt-free carve-out rather than working capital.
The result is a normalized, defensible target, the level of working capital a normal owner needs to run the business through a normal cycle.
The closing true-up
At closing, the actual working capital delivered is measured against the peg. If the seller delivers more than the peg, the buyer pays the difference. If they deliver less, the purchase price is reduced. A second, final true-up usually happens 60 to 90 days after closing, once the closing balance sheet is finalized. This mechanic is why the peg is negotiated so hard: every dollar of difference between the peg and the delivered amount is a dollar of purchase price.
Why it pairs with the rest of the analysis
The peg is only as good as the balance sheet behind it. A proof of cash confirms the cash side is real, and the working capital review confirms receivables are collectible and payables are complete. A peg built on a balance sheet that has not been tested is a number waiting to be disputed.
Frequently asked questions
Who sets the net working capital peg?
It is negotiated between buyer and seller, but both sides usually rely on an independent analysis to anchor the number. Presenting a normalized, well-documented target early, often as part of a sell-side package, takes the surprise out of the negotiation.
What is the difference between the peg and actual working capital at close?
The peg is the agreed target; the actual is what the business delivers on the closing date. The gap between them drives a dollar-for-dollar adjustment to the purchase price, settled through the closing and post-closing true-up.
Does the peg include cash?
Usually not. Most deals are cash-free, debt-free, so cash and interest-bearing debt are handled separately and the peg covers operating working capital only. The exact definition is spelled out in the purchase agreement, and the underlying records should follow the applicable framework, such as the standards from CPA Canada.
Where to next
If you are negotiating a deal and want the working capital target set before it becomes a dispute, our transaction advisory team builds the peg into every Quality of Earnings report.
