When you finally agree on a purchase price for your business sale, the conversation is far from over. One of the most contentious—and financially significant—negotiations happens after price: working capital. Buyers expect to receive a business with enough cash, receivables, and inventory to operate smoothly from day one. Sellers want to walk away with every surplus dollar. The mechanism that balances these competing interests is called the working capital peg. Understanding how pegs are set, calculated, and resolved can mean the difference between a closing that feels fair and one that triggers a post-close dispute. This article explains what working capital includes in a sale, how targets are established, how true-ups function, and how disputes are resolved, with practical guidance for Illinois business owners.
What Working Capital Actually Includes in a Sale
Working capital is the lifeblood of daily operations. In an M&A context, it is not just the accounting definition of current assets minus current liabilities. Transactional working capital includes the specific components a buyer needs to maintain revenue and service obligations immediately after closing.
Current Assets Typically Included: Accounts receivable from trade customers, provided they are collectible within normal terms. Inventory at cost or market value, depending on the purchase agreement. Prepaid expenses like insurance, rent, or subscriptions that benefit the buyer post-close. Cash may be included or excluded, depending on the structure. In asset sales, the buyer usually requires a minimum cash amount to fund payroll and payables in the first week. In stock sales, all balance sheet accounts transfer by default.
Current Liabilities Typically Included: Accounts payable to vendors and suppliers. Accrued expenses such as wages, benefits, and taxes. Deferred revenue for services paid in advance that the buyer will be obligated to fulfill. Short-term debt and lines of credit are usually excluded unless explicitly assumed by the buyer.
Some items are explicitly negotiated. For example, if the seller has $50,000 in prepaid insurance that covers the six months post-close, the buyer might argue that only three months should count, with the seller reimbursing the remainder. Similarly, if receivables are over 90 days old, buyers may insist on an aging reserve or exclusion from the peg. A seller of a Chicago-area distribution company should understand these nuances before engaging potential acquirers.
Calculating the Average vs Peg Working Capital Target
The working capital peg is not a random number. It is typically calculated as the average net working capital over a representative historical period—most commonly the trailing twelve months—sometimes adjusted for seasonality or growth trends.
Trailing Twelve Months: Both parties review monthly balance sheets for the past year, calculate net working capital for each month, and average the results. Months with unusual spikes or drops are examined for one-time events. An Illinois landscaping business with strong seasonality might see working capital swing from $150,000 in March to $30,000 in August. Using a simple average smooths these variances, but both parties should acknowledge the cycle.
Seasonal Adjustments: For highly seasonal businesses, the parties may agree to use a multi-year average, or to weight certain months more heavily. Some deals use a seller-friendly approach that pegs working capital at the lowest monthly point, while others negotiate a buyer-friendly peg at the highest. These terms are heavily negotiated and reflect leverage, preparation, and the quality of advisory counsel.
Growth Adjustments: If revenue has grown 30% year-over-year, the historical trailing twelve months may understate the working capital needed to support current operations. Buyers may argue for a peg based on a percentage of projected revenue, or a more recent three-month average. Sellers resist these methods unless the growth is clearly sustainable and already reflected in the purchase price multiple.
Definition Disputes: What counts as a current asset or liability? The purchase agreement must be exhaustive. One common source of conflict is deferred revenue: sellers view it as a non-cash liability that will be earned over time, while buyers view it as an obligation they must fulfill using future labor and inventory. Similarly, accrued vacation time, warranty reserves, and estimated tax liabilities must be defined and agreed upon upfront. Never leave these terms ambiguous in the letter of intent.
True-Up Mechanics After Closing
No matter how carefully the peg is calculated, the actual working capital delivered at closing rarely matches exactly. A true-up mechanism addresses this gap by reconciling estimated working capital against final numbers after the books are closed.
Estimates at Closing: Because final numbers are not available the day ownership transfers, the seller prepares an estimated balance sheet as of the closing date. The buyer reviews and either accepts or objects. If accepted, the purchase price is adjusted up or down based on the estimated variance from the peg. For example, if the peg is $400,000 and the estimated working capital delivered is $450,000, the buyer typically pays the seller an additional $50,000 at closing.
Final Statement Preparation: After closing, the buyer (or sometimes the seller, depending on the agreement) prepares a final working capital statement within a specified window—usually 60 to 90 days. This statement reconciles the estimate against actual receipts, payables, inventory counts, and accruals. The parties then compare the final working capital to the peg.
Escrow and Payment: Most deals set aside 8% to 12% of the purchase price in escrow for 6 to 18 months. The working capital true-up is typically the first claim against escrow. If final working capital exceeds the peg, the escrow releases funds to the seller. If it falls short, funds are released to the buyer to cover the shortfall. In many Illinois transactions, especially those with SBA financing, escrow management is handled by an independent third party selected by the lender.
The true-up process is where many deals turn adversarial. A seller who inflated inventory values, understated payables, or failed to collect overdue receivables will face a post-closing reckoning. Conversely, a buyer who drags out the final statement preparation or invents disputes to preserve escrow leverage can strain the relationship and trigger costly arbitration. Professionalism, transparency, and well-documented financials are the best protections for both sides.
How Working Capital Disputes Get Resolved
Even with good faith on both sides, disagreements over working capital calculations are common. The purchase agreement must specify a clear, enforceable dispute resolution mechanism.
Independent Accountant or Arbitrator: Most agreements require that deadlocked disputes be submitted to an independent certified public accountant or an arbitration firm. The selected firm reviews submissions from both parties and issues a binding determination. The parties usually split the cost equally unless the decision overwhelmingly favors one side, in which case the loser may be responsible for fees. A neutral CPA with M&A experience is ideal because they understand the standard practices and can move quickly.
Scope of Review: The arbitrator is typically limited to reviewing whether the final working capital statement was prepared in accordance with the accounting principles defined in the purchase agreement. They do not renegotiate the peg or second-guess the original valuation. This narrow scope underscores why the initial definitions matter so much. If your agreement says inventory is valued at the lower of cost or market but your books use replacement cost, the arbitrator will likely rule against you regardless of your intent.
Timeline and Escrow Impact: Disputes that escalate to arbitration can take 60 to 120 days to resolve. During that time, the escrow remains frozen, and the seller cannot access funds they may need for taxes, reinvestment, or personal obligations. Buyers also face uncertainty and cannot fully integrate the business until the financial picture is finalized. For these reasons, many parties settle informally even when they believe they are right.
Prevention Through Preparation: The best way to win a working capital dispute is to avoid it. Sellers should maintain accurate monthly balance sheets throughout the year before sale. Reconcile accounts receivable, inventory, prepaid items, payables, and accruals monthly. Identify and resolve discrepancies before the buyer’s diligence team arrives. Buyers should conduct pre-close due diligence focused specifically on working capital components, including a physical inventory count and an AR aging review. A professional broker can facilitate this process and prevent surprises on both sides.
Working capital is not an afterthought. In many Illinois business sales, it is the single largest variable affecting the seller’s net proceeds after the headline price. Getting it right requires clarity, precision, and a purchase agreement that leaves nothing to interpretation. If you are preparing to sell your business, invest time and advisory resources into working capital modeling before you go to market. Your future self will thank you when the true-up comes back within five percent of the peg and both parties shake hands in goodwill.
Frequently Asked Questions
What is a working capital peg in a business sale?
A working capital peg is the target amount of net working capital the seller must deliver at closing. If actual working capital exceeds the peg, the buyer pays the seller the difference; if it falls short, the seller owes the buyer.
How is working capital calculated for a sale?
It is usually the trailing twelve-month average of current assets (excluding cash) minus current liabilities (excluding debt). Both parties define exactly which items count toward the calculation in the purchase agreement.
What happens if there is a working capital dispute after closing?
Most purchase agreements include a dispute resolution clause requiring an independent CPA or arbitrator to issue a binding decision. Escrow funds are held until the dispute is resolved.
Is cash included in working capital for a business sale?
It depends on the agreement. Asset sales often exclude operating cash, while stock sales may include it by default. Many deals negotiate a minimum cash amount that must remain in the business at closing.
How can a seller minimize true-up risk?
By maintaining clean, reconciled monthly balance sheets, conducting pre-sale inventory counts, collecting old receivables, and defining every working capital component clearly in the purchase agreement before signing.
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