Working Capital Peg

What Is a Working Capital Peg?

A working capital peg (also called a “working capital target” or “normalised working capital”) is the agreed-upon benchmark level of net working capital that the target company is expected to deliver at closing. If actual working capital at closing exceeds the peg, the buyer pays more. If it falls below the peg, the purchase price is reduced by the shortfall.

The working capital peg mechanism exists because M&A transactions are priced on enterprise value, which assumes the business is delivered with a “normal” level of working capital — a principle central to the M&A process. Without this mechanism, a seller could extract value by running down inventory, accelerating collections, or delaying payments before closing — effectively stripping working capital out of the business.

Why the Peg Matters

Working capital is the operational lifeblood of a business. It includes:

• Current assets — accounts receivable, inventory, prepaid expenses
• Current liabilities — accounts payable, accrued expenses, deferred revenue

If the buyer acquires a business with less working capital than normal, they must inject their own cash to sustain operations. Conversely, if working capital is above normal, the buyer receives a windfall. The peg ensures neither party is unfairly advantaged.

Setting the Peg

Methodology

The peg is typically calculated as the average monthly net working capital over a trailing 12–24 month period, with adjustments for:

• Seasonality — if the business has seasonal working capital swings, the period should capture a full cycle or the peg should be set at a mid-cycle level
• Non-recurring items — removing unusual receivables, payables, or inventory adjustments (a key focus area in M&A due diligence)
• Growth adjustments — normalising for organic growth that naturally increases working capital
• Excluded items — cash, debt, tax-related balances, and transaction-related items are typically excluded from working capital

Common Approaches

Approach	Description	When Used
Trailing average	Average of monthly NWC over 12–24 months	Stable businesses
Median month	Median monthly NWC to reduce outlier impact	Businesses with occasional spikes
Seasonal adjustment	Peg varies by month of expected closing	Highly seasonal businesses
Last twelve months	Average over the most recent twelve months	Businesses with clear growth trends

The Closing Adjustment Mechanism

Process

1. Estimated closing statement — at closing, the parties use estimated working capital to determine the preliminary purchase price
2. Post-closing true-up — within 60–90 days after closing, the buyer prepares a closing balance sheet showing actual working capital
3. Review period — the seller has a defined window (typically 30–60 days) to review and dispute the buyer’s calculations
4. Dispute resolution — unresolved disagreements are referred to an independent accounting firm whose determination is binding
5. Payment — the difference between actual working capital and the peg is settled by payment from buyer to seller (if above the peg) or seller to buyer (if below)

Collar Mechanism

Some agreements include a collar — a range around the peg within which no adjustment is made:

• If actual working capital is within ±$500K of the peg, no adjustment occurs
• This prevents minor fluctuations from triggering payment obligations and reduces post-closing friction

Negotiation Considerations

Seller Perspective

• Push for a lower peg, as this makes it more likely that closing working capital will exceed the target (resulting in an upward price adjustment)
• Resist inclusion of items that are difficult to control or measure precisely
• Negotiate a collar to avoid nuisance adjustments

Buyer Perspective

• Advocate for a higher peg to ensure adequate working capital is delivered
• Insist on clear definitions and methodologies aligned with historical accounting practices
• Ensure the right to prepare the closing balance sheet using consistent accounting policies

Working Capital Pegs in Asia Pacific

Establishing working capital pegs in Asia Pacific transactions requires careful attention to local business practices (Corporate Finance Institute). Payment customs vary significantly — extended payment terms are common in some Asian markets, affecting receivables cycles. Seasonal patterns may follow local calendar cycles (e.g., Chinese New Year, Golden Week in Japan) that differ from Western fiscal year patterns. For cross-border transactions, currency denomination of the working capital peg and exchange rate mechanisms add another layer of complexity. AI-native platforms like Amafi help advisors analyse historical working capital patterns across Asia Pacific targets, supporting the establishment of fair and accurate peg levels.