07 Sep What Is Working Capital and Why Buyers Use It to Adjust Your Purchase Price
When you agree on a purchase price for your business, that number rarely stays fixed all the way to closing. One of the most common reasons it moves is something many owners have never heard of until it shows up in a deal: working capital.
Working capital is the cash and short term resources a business needs to keep running day to day. It’s calculated as current assets, things like cash, accounts receivable, and inventory, minus current liabilities, things like accounts payable and other short term obligations. In simple terms, it’s the fuel that keeps the lights on between now and when the next round of revenue comes in.
When a buyer agrees to purchase your business, they’re not just buying your equipment, your customer list, or your brand. They’re also expecting to receive a business that can keep operating without them having to inject additional cash the day after closing. So buyers typically set a working capital target, often called a peg, based on your business’s historical average over the past twelve months or so.
At closing, your actual working capital is compared to that peg. If you deliver less working capital than expected, the purchase price is reduced by the difference. If you deliver more, you may actually receive additional proceeds. This is often called a true up, and it happens after the deal has technically closed, once the final numbers are confirmed.
Buyers use this mechanism for a simple reason: it protects them from a seller who collects every outstanding invoice, delays paying vendors, or lets inventory run low in the months before a sale to boost their own payout at closing. A working capital adjustment keeps the business whole for its new owner.
For sellers, the best move is to get ahead of this instead of being surprised by it. Start tracking your working capital trends well before you go to market so you understand what a normal, healthy level looks like for your business. Avoid making unusual changes to how quickly you collect receivables or pay vendors in the months leading up to a sale, since buyers and their advisors will look closely at that pattern during diligence. And make sure the working capital target and the method for calculating it are clearly defined and negotiated, ideally starting in the letter of intent, so there are no surprises later.
Working capital is just one of several adjustments that can affect what you actually walk away with at closing. Understanding it now, well before you’re in active negotiations, puts you in a much stronger position when the time comes.
Related reading: Pre-Sale Financial Cleanup: The 6 Reports Buyers in the U.S. Will Ask For First and What Happens to Business Debt When You Sell Your Company?
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Disclaimer: This content is for general educational purposes only and should not be considered financial, legal, or tax advice. Every business and situation is unique. Please consult a qualified advisor before making any decisions.