What is Working Capital in M&A?
Working capital is one of the most frequently misunderstood elements of M&A deal economics — and one of the most common sources of post-signing surprises for sellers. The working capital adjustment mechanism in a sale transaction can result in the seller receiving significantly more or less than the headline enterprise value, depending on the working capital balance at closing and how the peg is negotiated.
What working capital is
Working capital in M&A is typically defined as current assets minus current liabilities — specifically trade receivables, inventories, and prepayments, minus trade payables and accruals. Cash and debt are excluded from the working capital calculation (they are addressed separately in the net debt adjustment). The working capital balance reflects the operational liquidity embedded in the business — the amount of capital tied up in the day-to-day operation of the trading cycle.
Why working capital matters in deal pricing
The enterprise value agreed in an LOI is typically stated on the basis that the business has a 'normal' level of working capital at closing. If the business has more working capital than normal at closing, the seller receives additional consideration (they are leaving more value in the business than was assumed). If it has less, the seller receives a deduction. The normal working capital — the 'peg' — is the negotiated baseline. Getting the peg right, and understanding what constitutes normal working capital for your specific business, is one of the most important financial negotiations in any M&A transaction.
How the peg is negotiated
The working capital peg is typically set at the average of the trailing 12 months of working capital balances, often calculated on a monthly basis to capture seasonality. Sellers who have not prepared for this negotiation often find themselves in a dispute over what the 'right' peg is — particularly in seasonal businesses where the timing of closing relative to the seasonal cycle significantly affects the working capital balance. Understanding your working capital profile — its seasonality, its drivers, and its trajectory — before entering negotiations is essential.
Locked box vs. completion accounts
There are two principal mechanisms for addressing the working capital and net debt adjustments in M&A. The completion accounts mechanism is the traditional approach: the consideration is adjusted based on the actual balance sheet at closing, determined after the deal closes. This is more flexible but creates post-closing disputes. The locked box mechanism fixes the economic transfer date at a specific historical balance sheet date, and the buyer pays a set consideration based on that balance sheet. Any cash generated between the locked box date and closing belongs to the buyer — the seller may receive 'leakage protection' or 'interest accrual' for the intervening period. Locked box is common in UK and European mid-market transactions; completion accounts are more common in US transactions.
Common traps for sellers
The most common working capital traps for sellers include: selling in a period where seasonal working capital is high (leaving less cash at closing), which gets trapped in the adjustment; accepting a low peg set by the buyer that results in a deemed surplus at closing that the buyer pockets; and failing to understand how the specific SPA definition of working capital includes or excludes certain balance sheet items. Sellers who do not have advisors who scrutinise the working capital mechanics in the LOI frequently find that the working capital adjustment reduces their net proceeds by more than expected.
Key takeaways
Working capital adjustments ensure the buyer receives the business with a normal level of operational liquidity — sellers receive more or less depending on whether the closing balance is above or below the peg.
The working capital peg — the normalised baseline — is one of the most important and sometimes underestimated financial negotiations in any transaction.
Completion accounts adjust consideration after closing based on actual balances; locked box fixes the economics at a historical balance sheet date.
Seasonal businesses face particular working capital risk — the timing of closing relative to seasonal peaks can significantly affect net proceeds.
Working capital traps are a common source of post-signing seller disappointment — proper preparation and advisor scrutiny of the mechanics in the LOI is essential.
Related M&A terms
Continue building your M&A knowledge with these related guides.
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