Key takeaways
- The working capital peg is a price negotiation, not an accounting exercise.
- Build your own trailing 12-month working capital baseline before the LOI.
- Exclude non-operating items from the peg definition in the LOI, not later.
- Document seasonal swings so buyers can't use them as a post-close weapon.
- A $200K peg dispute at 6x is a $1.2M enterprise value argument.
Most founders focus on purchase price, rollover, and earnouts when negotiating a sale. But one of the most common sources of value leakage in a middle market transaction is the working capital target. It is rarely the headline issue in the process, yet it often determines how much cash the seller actually receives at close.
38% of lower-middle-market transactions experience a working capital shortfall at closing that reduces proceeds below the LOI headline, with a median adjustment of $340K in the $10–50M deal range (SRS Acquiom 2024) (SRS Acquiom 2024), with a median adjustment of $340K against the LOI headline in the $10–50M deal range.
In 62% of transactions where a working capital dispute arose post-close, the methodology used to set the target, not the actual balance, was the contested issue: specifically, whether seasonality and unusual items were properly normalized.
Sellers who proactively proposed a working capital methodology (with documented ordinary-course analysis) in LOI negotiations achieved targets 15–22% closer to their operational baseline than those who accepted the buyer-proposed approach without challenge.
What a working capital target is
In most transactions, the buyer expects the business to be delivered with a normalized level of working capital at closing. See transaction readiness for how this fits the broader preparation checklist. That means enough accounts receivable, inventory, accounts payable, and related operating balances to run the business in the ordinary course immediately after the transaction closes.
If the business is delivered below that agreed target, the purchase price is usually reduced dollar-for-dollar. If it is delivered above target, the seller may receive an upward adjustment. In practice, the target is often framed as a neutral mechanic. It rarely feels neutral once the final closing statement is prepared.
Why founders underestimate it
Founders often treat the working capital target as an accounting exercise rather than a valuation issue. That is a mistake. The target effectively determines how much operating liquidity the seller is required to leave behind as part of the deal.
A target set too high can transfer meaningful value to the buyer without changing the headline purchase price. The seller may believe they negotiated a strong outcome, only to discover at closing that the actual cash proceeds are lower because the business did not meet the agreed working capital level.
Where disputes come from
The most common problems are not dramatic. They usually come from seemingly technical decisions: which historical periods were used to set the target, whether seasonality was handled correctly, how unusual customer collections or inventory builds were treated, and whether specific balance-sheet accounts were included or excluded from the calculation.
These issues matter because working capital in founder-owned businesses is often less stable than buyers assume. Customer concentration, project timing, inventory cycles, and owner-managed payables practices can all distort the historical average if they are not normalized properly.
Why the target can be economically misleading
A simple trailing-average approach may look objective, but it can still produce the wrong answer. If the business recently grew quickly, changed terms with customers or vendors, or went through an unusual seasonal period, the average may not reflect the amount of working capital actually required to operate the business on a go-forward basis.
The issue is not whether the math is correct. The issue is whether the math reflects commercial reality. Buyers will usually argue for a target that maximizes post-close protection. Sellers need to evaluate whether that target reflects ordinary-course operations or simply shifts more value out of the purchase price and into the balance sheet they leave behind.
How to approach it more intelligently
The right way to negotiate a working capital target is to treat it as part of total consideration, not as a side schedule for the lawyers and accountants to handle at the end. Sellers should understand the historical pattern, identify distortions, and build a clear view of what ordinary-course working capital actually looks like for the business.
How to Evaluate a Working Capital Target: A Seller's Framework
Step 1: Map the historical baseline
Pull 18–24 months of month-end working capital by account. Identify the range, the average, and any months that were distorted by unusual activity.
Step 2: Document distortions
Flag seasonal peaks, unusual customer collections, inventory builds, or payables timing that inflated or deflated the period average. Each distortion should have a written explanation.
Step 3: Define ordinary-course
From the normalized data, identify what the business actually requires to operate month-to-month, not the best month, not the worst, but the true operating baseline.
Step 4: Evaluate buyer methodology
When the buyer proposes a target, trace their calculation back to the underlying data. Identify which periods and accounts they used and whether the methodology is consistent with your ordinary-course view.
Step 5: Negotiate as total consideration
Treat the target as part of total deal economics. A target set $500K above ordinary-course working capital is economically equivalent to a $500K reduction in purchase price, negotiate it accordingly.
That usually means reviewing seasonality, recent operating changes, unusual collections or payables timing, inventory volatility, and account-by-account definitions well before the purchase agreement is finalized. The better prepared seller is not just arguing about arithmetic. They are explaining the operating logic behind the target. Working capital mechanics are directly connected to the letter of intent terms that most founders accept without full analysis.
A $22M regional HVAC services company entered diligence with a buyer who proposed a $4.1M working capital target based on a trailing 12-month average. The seller's controller identified that three months in the average fell during an unusually high-inventory period driven by a supply-chain pre-buy the business would not repeat. Renegotiating the trailing period and excluding the pre-buy months reduced the target by $390K. At close, the business delivered working capital of $3.75M, a figure consistent with ordinary-course operations. Had the original target held, the closing adjustment would have been $350K against the seller. The renegotiation required one conversation and two weeks of documentation work.
The founder takeaway
Headline price is not the same as realized value. Working capital targets, like earnouts, are one of the mechanisms through which value gets repriced after the letter of intent feels settled. Founders should evaluate them with the same seriousness they bring to headline valuation, rollover economics, and post-close obligations.
A strong M&A process does not just negotiate price well. It protects the pieces of structure that determine how much of that price actually reaches the seller.
Frequently asked questions
What is a working capital target in an M&A transaction?
A working capital target is the agreed level of current assets minus current liabilities that the seller is required to deliver at closing. If the business closes with working capital below the target, the purchase price is reduced dollar-for-dollar. If it closes above the target, the seller may receive an upward adjustment. It is one of the most common sources of value leakage in founder-owned transactions because it is treated as a technical matter rather than a valuation issue.
Why do working capital disputes happen after signing?
Most disputes arise because the target was set using a methodology, typically a trailing average, that did not account for seasonality, recent operating changes, or unusual balance-sheet activity. Once the purchase agreement is signed, the seller is locked into a target that may not reflect how the business ordinarily operates. Disputes surface at closing when the final statement is prepared and the actual balance differs from the agreed peg.
How much can a working capital target affect closing proceeds?
In lower middle market transactions, working capital shortfalls at closing often range from $200K to $1M+ depending on business size, capital intensity, and how the target was set. That range represents a significant portion of total consideration and often goes unmodeled by sellers who focus exclusively on headline purchase price during negotiations.
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