Why your working capital peg matters more than your multiple
Owners often negotiate the multiple for weeks while the working capital true-up quietly receives far less attention. Here's why the peg deserves equal scrutiny.
You negotiate a $10M purchase price. You celebrate. The deal closes, and 90 days later you get a notice from the buyer stating that the business was delivered with insufficient working capital, and you owe them $400,000 back.
This is the working capital true-up, and it is a part of the transaction where significant seller value can quietly slip away.
When a buyer purchases a going concern, they expect it to have enough cash, receivables, and inventory to operate on day one without an immediate capital injection. The "peg" is the agreed-upon target for what that normal level of working capital is.
If you deliver more working capital than the peg at closing, the buyer pays you the difference. If you deliver less, you owe the buyer the difference out of your proceeds.
The trap for trades and manufacturing businesses is seasonality and the revenue cycle. In HVAC, your working capital needs in July look very different than in February. If the buyer's accountants calculate the peg based on a 12-month trailing average, but you happen to close at the trough of your cash cycle, you will face a massive shortfall.
Brokers rarely protect you here because the working capital true-up happens after closing. Their fee has already been paid. You are left fighting a team of private equity accountants on your own.
Getting the peg right requires understanding your specific cash conversion cycle, excluding one-time inventory build-ups from the historical average, and ensuring the definition of "current assets" and "current liabilities" matches how you actually run the business. This is not a legal issue—it is an operational one. And it is something I review in detail before we agree to any LOI.