What Is a Working Capital Peg?
Most private deals are priced on a cash-free, debt-free basis with the assumption that the business comes with a normal level of working capital, meaning enough receivables, inventory, and prepaid items net of payables and accruals to operate without an immediate cash injection. The working capital peg is the number the parties agree represents that normal level.
Without a peg, a seller could quietly harvest value in the months before closing by collecting receivables aggressively, running inventory down, and delaying payments to vendors, leaving the buyer to refill the tank after close. The peg neutralizes that incentive because any shortfall against the target comes straight out of the seller's proceeds.
How the Peg Is Set and Trued Up
The peg is usually based on the trailing twelve-month average of net working capital, defined as current assets excluding cash minus current liabilities excluding debt, with the exact line items negotiated in the purchase agreement. A twelve-month average smooths seasonality, though businesses with pronounced seasonal swings often fight over whether an average, a seasonal reference month, or a multi-year view is the fairest benchmark. The quality of earnings report typically supplies the underlying data.
At closing, the buyer funds based on an estimated closing balance sheet, then prepares a final closing statement within a set period, often 60 to 90 days. If delivered working capital exceeds the peg, the buyer pays the surplus to the seller; if it falls short, the seller refunds the difference, frequently out of an escrow. Disputes over the calculation go to an independent accountant named in the agreement.
Why the Peg Matters
The peg moves real money dollar-for-dollar, so a peg set $3 million too high or too low shifts $3 million between buyer and seller regardless of the headline price. Sophisticated parties treat the definition of working capital and the peg level as a second price negotiation, and diligence teams comb through classification questions such as whether deferred revenue or accrued bonuses count as working capital or as debt-like items.
For anyone recruiting into M&A or private equity, the peg is a favorite topic for testing whether a candidate understands how deals actually close rather than just how models are built. A crisp explanation covers why the peg exists, how the true-up works, and how it interacts with the cash-free, debt-free construct in the enterprise-to-equity value bridge.
