Short answer
- The peg is the normal level of working capital the business must deliver at closing.
- It's usually a trailing twelve-month average, adjusted for seasonality and one-time spikes.
- Above the peg, the seller gets paid more; below it, the price drops dollar for dollar.
What the working capital peg is
Most business sales are "cash-free, debt-free": the seller keeps the cash and pays off the debt. But the buyer expects the business to come with enough working capital to keep running, meaning receivables, inventory and payables at a normal level. The working capital peg is that agreed normal level. At closing, actual working capital is compared to the peg, and the price moves up or down dollar for dollar.
How it's calculated
- Agree what's in it. Usually accounts receivable, inventory, prepaid expenses, accounts payable and accrued operating expenses. Cash, debt and income taxes are usually excluded.
- Look back. Average the monthly balances over the trailing twelve months, sometimes eighteen, to smooth out swings.
- Adjust for seasonality. If the business peaks in summer, a straight average can mislead. The peg should reflect the month the deal closes.
- Normalize. Remove one-time spikes, like a bulk inventory buy.
A simple example
| Agreed peg | $400,000 |
|---|---|
| Actual working capital at closing | $350,000 |
| Price adjustment | Price reduced by $50,000 |
If working capital comes in at $450,000 instead, the buyer pays the seller $50,000 more. A final true-up usually happens 30 to 90 days after closing, and that's where most disputes happen.
Customer deposits: the construction-company trap
Contractors and many service businesses collect deposits before the work is done. That cash is a liability: the buyer inherits the obligation to do the work. Buyers will treat unearned deposits as a reduction to working capital or as debt, which can cut the cash a seller takes home by a lot more than expected. If you're selling a business that takes deposits, settle the treatment in the LOI, not at closing. My guide to selling a construction company covers this in more detail.
Does a small business deal need a peg?
Many small deals skip a formal peg and instead list exactly which assets transfer, often with inventory counted at closing. That's fine for simple businesses. Once receivables, payables or deposits are significant, a peg protects both sides from a business that's been drained, or stuffed, before closing.
Tips for sellers and buyers
- Sellers: don't stretch payables or chase receivables right before closing. It shows up in the true-up.
- Buyers: test the peg against twelve months of monthly balance sheets, not just the year-end.
- Both: define every account in the purchase agreement and agree who resolves disputes.
FAQ
What is a working capital peg?
The agreed normal level of net working capital, usually receivables plus inventory minus payables and accrued expenses, that a business must deliver at closing. The price adjusts dollar for dollar above or below it.
How is a working capital peg calculated?
Typically as the average of monthly net working capital over the trailing twelve months, adjusted for seasonality and one-time items.
Are customer deposits included in working capital?
Unearned customer deposits are a liability. Buyers typically treat them as a reduction to working capital or as debt, which reduces the seller's proceeds.
Sources
This guide is general information, not legal, tax or lending advice. SBA rules and Florida law change; confirm current terms with your lender, attorney and CPA.