Working Capital Adjustments at Closing: The Peg Trap Every SMB Buyer Misses

The most expensive line item in a small business acquisition is usually not the headline price.

It's the line that adjusts the headline price at closing — the working capital adjustment — and it routinely moves more dollars between buyer and seller than every other negotiated clause in the purchase agreement combined. Buyers who understand the mechanism walk into closing knowing exactly how much they'll wire. Buyers who don't show up at closing and find out the seller's accountant ran a calculation they hadn't seen, the broker's lawyer signed off on it, and the price they thought they agreed to is now $80,000 higher.

This post walks through what a working capital adjustment is, how the peg gets set, and where the dollars move. It assumes you've already read our LOI guide and understand how the LOI flows into the definitive purchase agreement.

What a Working Capital Adjustment Is and Why It Exists

The basic premise: a business can't operate without working capital. Accounts receivable need to be collected. Inventory needs to be on the shelf. Vendors expect to be paid on net terms. Payroll runs every two weeks. The buyer steps into all of these obligations on day one.

If the seller takes everything liquid out of the business before close — collects all the receivables, runs the inventory down, stretches vendor payables — the buyer inherits a business that needs an immediate capital injection just to keep the lights on. That's not what the buyer agreed to pay for.

The working capital adjustment exists to prevent that outcome. It says: the business should transfer with enough operating working capital to run normally. If it doesn't, the seller compensates the buyer. If it transfers with more than normal, the buyer compensates the seller.

The mechanism centers on a single number called the working capital peg (also called the "target" or "normalized working capital level"). The peg is supposed to represent the working capital level a normal, healthy operation of this business sustains.

At closing, the seller's accountant computes actual working capital as of the close date. That number is compared to the peg. The difference is settled in cash, dollar-for-dollar.

What's Included in Working Capital for This Purpose

The standard definition for an SMB acquisition working capital schedule:

Included current assets:

• Accounts receivable (net of an allowance for doubtful accounts)
• Inventory (typically at lower of cost or market, with obsolete/slow-moving items excluded)
• Prepaid expenses
• Other current operating assets (e.g., prepaid insurance, prepaid software, prepaid rent)

Included current liabilities:

• Accounts payable
• Accrued expenses
• Accrued payroll and payroll taxes
• Accrued employee benefits (PTO, bonuses)
• Sales tax payable
• Customer deposits
• Deferred revenue
• Other current operating liabilities

Excluded from both sides:

• Cash and equivalents
• Marketable securities
• Short-term debt and the current portion of long-term debt
• Income taxes payable and deferred tax balances
• Intercompany balances (between the seller and any affiliated entities)
• Anything related to the seller personally that won't transfer

The cash exclusion is important. Almost all SMB deals are structured "cash-free, debt-free" — the seller keeps any cash in the business at close and uses it to pay off all debt and to settle any tax liabilities. Both sides of the balance sheet are stripped of those items before working capital is computed.

The cleanest way to think about it: working capital, for purchase-agreement purposes, is the operating capital that turns over in the normal course of business. It excludes the financial structure of the business (cash and debt) and the seller's personal balances.

How the Peg Gets Set

The peg is usually the historical average operating working capital, computed monthly over a defined trailing window. The window length is negotiated — common choices are 12 months, 24 months, 6 months, and 3 months.

The shorter the window, the more the peg reflects recent operating reality. The longer the window, the more it smooths out seasonality.

Most defensible default: trailing 12-month average computed monthly. This captures a full operating cycle, smooths seasonal swings (inventory builds before peak season, AR builds at month-end), and is hard for either side to game in the short term.

When to push for a different window:

• Highly seasonal business: a trailing 24-month window captures two full seasonal cycles and reduces the impact of a single anomalous year.
• Growing business: a 6-month window may better reflect the current run-rate working capital need than a 12-month average that includes a smaller-scale prior period.
• Declining business: a 24-month window favors the buyer here, since the older months will likely show higher working capital and pull the peg up.

The seller's broker will propose a window. The buyer should compute the peg under multiple windows and propose the one that best reflects normal operations. The negotiation is which window is fairer — not whether the peg should exist.

The Mechanics: Estimated Closing Statement and Post-Close True-Up

The settlement happens in two stages.

Stage 1: Estimated closing statement.

Five to ten days before close, the seller prepares an estimated closing balance sheet — usually as of the most recent month-end before close. The seller computes working capital as of that date and compares it to the peg. The estimated adjustment is added to or subtracted from the purchase price at close.

If estimated working capital is below the peg, the cash purchase price at close is reduced by the difference. If above, the cash purchase price is increased.

Stage 2: Post-close true-up.

Within 60 to 120 days after close (the window is negotiated in the purchase agreement), the buyer's accountant computes the actual working capital as of the actual close date — with the benefit of having had time to collect the AR, work through the inventory, and reconcile the books.

The actual close-date working capital is compared to the peg. Any difference between the post-close actual and the pre-close estimate is settled in cash between buyer and seller.

This is where most disputes happen. The seller's pre-close estimate is almost always self-serving — receivables get marked up, AP gets marked down, slow inventory gets valued at full cost. The buyer's post-close true-up tightens those numbers. The seller objects. The lawyers get involved. In the worst case, the dispute goes to an independent accountant per the dispute resolution clause in the purchase agreement.

Where Sellers and Brokers Tend to Push

Three pressure points come up in almost every deal.

1. Setting the Peg Low

The most common move is to propose a peg that's below the true historical operating average. The broker will point to a low month — usually right after a big collection cycle or after inventory has been sold off — and propose that as the peg, or propose a 3-month window that conveniently includes the low months.

A buyer who doesn't compute the trailing average independently will accept the proposed peg because they don't have a basis to push back. That low peg means the seller can transfer the business with less working capital than it normally operates with — and the buyer steps in needing to inject the difference from their own pocket.

Counter: ask for 18 to 24 months of monthly balance sheets at the start of diligence. Compute the trailing 3-, 6-, 12-, and 24-month averages yourself. Use the result to anchor the peg negotiation.

2. Stripping Receivables and Inventory in the Run-Up to Close

Even with a peg set correctly, the seller can transfer the business with less working capital than the peg if they're aggressive about converting receivables to cash and running down inventory in the 30 to 60 days before close.

The peg adjustment will still work — actual working capital below the peg means the seller owes the buyer the difference. But disputes are common because the seller will argue that "everything was normal" while the buyer's true-up shows AR ran $40,000 below average that month.

Counter: include a covenant in the purchase agreement requiring the seller to operate "in the ordinary course of business" during the pre-close period, with specific examples of what's prohibited — accelerating AR collection, refusing to extend trade credit, running down inventory below normal reorder levels, delaying vendor payments to inflate AP.

3. Narrowing the Working Capital Definition

The third move is the most technical. The seller's lawyer will propose a working capital definition that excludes items that would otherwise count on the seller's side. The most common exclusions to push back on:

• Deferred revenue. The seller wants to exclude customer prepayments because including them as a liability reduces working capital and pulls the peg down. If customers have prepaid for services that the buyer will need to deliver, that deferred revenue is a real obligation. Include it.
• Customer deposits. Same logic. The buyer is taking on the obligation to deliver against the deposit. Include it.
• Accrued PTO and bonuses. Employees have earned these. The buyer will pay them out. Include them as accrued liabilities.
• Inventory reserves. Whether obsolete or slow-moving inventory is valued at full cost or at a reserve dramatically changes the inventory number. Define the reserve policy in the working capital schedule.

The general rule: if the buyer will be on the hook for something after close, it should reduce the seller's working capital number at close. If it's a real operating asset the buyer can use or convert to cash, it should increase the number.

Worked Example: A $2.4M Industrial Services Scenario

An illustrative scenario, with representative numbers, showing how a single peg miss compounds.

Five Protections Every Buyer Should Put in Place

In order of leverage:

1. Negotiate the Peg Before LOI

The single most effective protection. Most LOIs are silent on working capital and just say "the deal will include a customary working capital adjustment." The detail then moves to the purchase agreement, where the seller's broker controls the first draft.

Instead, push to put the peg number and the calculation methodology directly in the LOI. "Purchase price of $X assumes a working capital peg of $Y, computed as the trailing 12-month average of [defined items]." This forces the negotiation up front, when the buyer has the most leverage (the seller wants the LOI signed) and the cheapest exit option.

Many buyers don't realize they can do this. Brokers won't volunteer it. Ask.

2. Demand 18 to 24 Months of Monthly Balance Sheets

Without this data, the peg negotiation is asymmetric — the seller knows the actual averages and the buyer is guessing. With this data, the buyer can compute every possible window and propose the one that best reflects normal operations.

If the seller refuses to provide 18 months of monthly balance sheets, that's a meaningful flag. Either the books aren't well-maintained (a different problem) or the seller is hiding the seasonality that would justify a higher peg.

3. Define Every Working Capital Category in Detail

The purchase agreement should include a one-page "working capital schedule" that lists every line item included on both sides of the calculation, with the methodology for any line that involves judgment (inventory reserves, AR allowance, accrued PTO valuation). Footnotes matter. Vague definitions create disputes during the true-up.

The buyer's transaction CPA should draft or review this schedule. The legal language in the purchase agreement is necessary but not sufficient — the schedule is what controls the actual computation.

4. Lock in a 90 to 120 Day True-Up Window With Book Access

The true-up timeline should be 90 to 120 days post-close, not 30 or 60. Three reasons:

• AR collection patterns become clear over 90 days — if a "current" receivable at close turns into a 90-day past-due balance, that's information the buyer needs.
• Inventory turnover patterns settle out — slow-moving or obsolete inventory becomes visible.
• The first quarterly close cycle catches missed accruals and reclassifications.

The buyer also needs unrestricted access to the seller's accounting records during the true-up period — the books, the GL, the bank statements, the customer subledger. Require this access in the purchase agreement.

5. Hold Back 5 to 10% of the Purchase Price in Escrow

A working capital escrow funds any net true-up payment from seller to buyer. Without an escrow, the buyer is reliant on the seller to wire money 90 days after close to settle a disputed adjustment. That's a hard collection.

Standard structure: 5% to 10% of the purchase price held in an independent escrow account for 90 to 180 days post-close. The escrow funds the working capital true-up first, with any remaining balance released to the seller after the true-up settles.

The escrow also protects against other post-close adjustments — undisclosed liabilities, indemnification claims, inventory shortfalls — but the working capital true-up is the most common draw.

The Pattern Across Deals

The working capital adjustment is one of the most common places first-time SMB buyers lose money relative to what they thought they were paying.

Not because the mechanism is hidden — the purchase agreement spells it out, the lawyers explain it, the broker mentions it. It's because the buyer doesn't understand the mechanism deeply enough to negotiate the peg correctly, doesn't have the data to challenge the seller's proposal, and accepts the broker's framing because it sounds technical and reasonable.

The buyers who negotiate this well treat the peg as a price negotiation — because it is one. A $50,000 swing in the peg is identical in dollar impact to a $50,000 swing in the headline price. The difference is that the headline price gets negotiated for weeks and the peg, in most deals, gets negotiated in a single conversation between attorneys.

Treat it accordingly. The peg should get the same scrutiny the price gets. The numbers are too large to leave to the lawyers.

If you're heading toward closing and don't have a clear answer to "what is the working capital peg, how was it calculated, and what does the trailing 12-month average actually show," that's the next question to put in front of the seller — before the purchase agreement is signed, not after.