The Working Capital Trap: How Sellers Lose Money at the Closing Table

Most sellers spend months negotiating the purchase price. They fight over the multiple, the structure, the earnout, the representations and warranties. They get to the closing table thinking they know what they are going to walk away with.

Then the working capital adjustment hits, and the number changes.

For sellers who do not understand how working capital adjustments work, this can feel like a ambush. For sellers who do understand it, it is a negotiation like any other. The difference between the two groups at the closing table is often six figures.

What working capital is

Working capital is current assets minus current liabilities. In plain language, it is the liquidity the business needs to operate day to day. Accounts receivable, inventory, and prepaid expenses are the main current assets. Accounts payable, accrued expenses, and deferred revenue are the main current liabilities.

When a buyer acquires a business, they expect to receive a “normal” level of working capital as part of the deal. The logic is that the business needs that capital to keep running, and the seller should leave it in place rather than pulling it out before close.

The mechanism for ensuring this is the working capital peg, a target level of working capital that the parties agree to at signing, with a dollar-for-dollar adjustment at close if the actual working capital delivered is above or below the target.

Where the trap is

The trap is in how the peg gets set, and how working capital gets calculated.

Most buyers propose a working capital peg based on a trailing average of the business’s historical working capital. That sounds objective. It is not always.

If a seller has been stretching payables in the months leading up to close, the accounts payable balance is artificially high, which reduces working capital. When the peg is set on a period that includes those stretched payables, the target looks normal. At close, the payables normalize and the actual working capital delivered is below the peg. The seller writes a check.

Conversely, if the seller has been collecting receivables aggressively and building up cash before close, they have inflated current assets and the working capital delivered at close will be higher than normal. That should favor the seller, but only if they negotiated to have cash included in the working capital calculation, which buyers often push to exclude.

The calculation of what goes in and what stays out of the working capital basket is a negotiation, not a formula. Sellers who do not engage with this negotiation end up with whatever the buyer proposed.

The adjustment mechanism

Here is how it works in practice. The parties agree on a target working capital peg, say $800K. At close, the actual working capital delivered is calculated. If it is $750K, the seller pays the buyer $50K. If it is $850K, the buyer pays the seller $50K.

These adjustments happen post-close, often sixty to ninety days after the transaction closes, based on a closing balance sheet prepared after the fact. By that point, the seller has already left. They are looking at a check they expected to receive and a number that does not match what they thought they had negotiated.

The disputes that arise from working capital adjustments are some of the most contentious post-close conversations in M&A. They are also largely avoidable.

How to protect yourself

Three things matter here.

• Understand your own working capital before negotiations start. Run a trailing twelve-month analysis of your working capital components. Know what normal looks like for your business. Know which months are high and which are low. If the peg is going to be set on a trailing average, know which periods the buyer is looking at and whether they are representative.
• Negotiate the definition, not just the number. What goes into the working capital calculation matters as much as the target. Cash in or out? How is deferred revenue treated? Which receivables are included and what is the aging threshold? These definitions can move the effective target by hundreds of thousands of dollars.
• Watch what you do with the business in the months before close. Stretching payables, pulling forward receivables collections, or reducing inventory to generate cash before close all have working capital consequences at closing. Understand the mechanics before you make those decisions.

Working capital is not the most exciting part of a deal negotiation. It is often where the most money quietly changes hands. Know the mechanism. Engage with the definition. And do not let the closing table be the first time you understand what the adjustment could look like.

Want to work one-on-one with me to get your business exit-ready? Apply now to schedule a free call where we go over your business in detail.  Apply for a FREE  Call Now >>

If you didn’t know, now you know.

* Every deal I look at is under NDA. The stories I discuss are real. Some identifying details — company name, specific geography, exact numbers — may have been changed to protect the seller. The lessons haven’t.