Glossary
7 Working Capital Mistakes That Blow Up SMB Acquisitions
In an M&A deal, net working capital is the current operating assets a business needs to run, such as receivables and inventory, minus its current operating liabilities, and the net working capital peg is the target level of it the seller must deliver at close. It is the part of a deal most likely to produce a fight at the closing table. The principle is simple: a buyer should receive the business with enough working capital to keep running, “with the gas in it.” The mistakes that break that principle are also simple, and avoidable. Here are seven.
- Setting the peg too low
Owners consistently believe a business runs on less working capital than it actually needs. Set the peg below the real requirement and the buyer is short of cash on day one. This is the most common working-capital error we see.
- Using a trailing-twelve-month average on a seasonal or growing business
A twelve-month average is the right default for a steady business. For a seasonal or fast-growing one, it can misstate the true requirement badly. The window should flex to a trailing three or six months when the data calls for it.
- Computing the peg and the true-up on different methods
This is the quiet deal-killer. If the peg is set one way and the closing true-up is calculated another, you manufacture a phantom adjustment that no one can explain. The peg and the true-up must use the same method. When they do, ordinary month-to-month errors net out instead of becoming a dispute.
- Ignoring an accounting-system migration
A mid-year switch between systems can corrupt the comparability of the balance sheet. Built on corrupted data, the peg is wrong from the start. The fix is to shorten the window to the period after the data becomes reliable and confirm it with a proof of cash.
- Mishandling deferred revenue
Deferred revenue is cash the business has collected for work it has not yet done. Whether it is treated as debt, left in the business, or taken by the seller changes the buyer’s position materially. Leaving it out of the working-capital conversation is a mistake the buyer pays for later.
- Letting a one-time swing set the peg
A single large receivable or a one-off inventory build can distort the picture if it lands inside the measurement window. The peg should reflect the normal operating requirement, not a moment.
- Closing without a defined true-up mechanism
A deal that closes on an estimated balance with no agreed mechanism to true it up afterward invites a dispute. The mechanism, and the method behind it, should be settled before close, not negotiated after.
Frequently asked questions
What does “buy the business with the gas in it” mean?
The buyer should receive enough working capital to operate normally from day one, without having to inject cash immediately. The peg sets that level.
Why must the peg and true-up use the same method?
Because consistency makes ordinary errors net out. Different methods create a swing that is an artifact of the math, not a real change in the business.
Is working capital handled cash-free and debt-free?
Typically yes. The peg is set on a cash-free, debt-free basis so the working-capital requirement is separated from the deal’s financing.
Where to next
The net working capital peg glossary entry covers the mechanics in depth, and the Quality of Earnings due diligence guide shows where it fits in the deal. To work through a peg on a live deal, contact our transaction advisory team.
