Working Capital Adjustment: The Closing-Day Surprise That Costs Sellers Money

What is a Working Capital Adjustment?

In almost every M&A deal, the buyer expects to receive the business with a ‘normal’ level of working capital — enough current assets (cash, AR, inventory) net of current liabilities (AP, accrued expenses) to run the business day one without injecting additional capital.

During negotiation, the parties agree on a working capital target (sometimes called ‘peg’). At closing, the actual delivered working capital is measured. If actual > target, the seller gets a price increase. If actual < target, the buyer gets a price reduction.

The mechanics are straightforward; the negotiation is not. The target itself — what counts as ‘normal’ working capital — is heavily negotiated and routinely costs unaware sellers six- and seven-figure amounts at closing.

How the Adjustment Is Calculated

The working capital adjustment follows a standard formula:

• Target working capital: Agreed in the purchase agreement (typically a 12-month trailing average of normalized monthly working capital)
• Actual closing working capital: Measured as of the closing date using agreed accounting principles
• Adjustment: Actual minus Target. Positive = price up. Negative = price down.

The adjustment is typically estimated at closing (with cash exchanged based on the estimate) and then finalized 30–90 days post-close after a true-up measurement. The post-close true-up is often where disputes arise.

Negotiating the Target

The most common way sellers lose money on working capital adjustments is failing to negotiate the target carefully. Two common buyer tactics:

Cherry-picked time periods

Buyers will propose a target based on a 12-month average. If the last 12 months included unusually high working capital periods (large slow-paying customers, peak inventory season), the target will be artificially high — meaning you’ll need to deliver more working capital than normal to avoid a price reduction.

Definitional games

What counts as working capital? Cash? Customer deposits? Deferred revenue? Accrued bonuses? Each of these has a real economic answer, but they’re negotiable, and each line item can move the target meaningfully.

Seasonal businesses especially need to scrutinize the target. If your business runs higher inventory in November and December, and closing happens in January (low inventory), you may deliver well below the ‘average’ target through no fault of your own. Either negotiate a seasonal adjustment formula or pick a closing date that aligns with normal working capital cycles.

Common Working Capital Disputes

AR aging and reserves

Are old receivables included at face value or discounted for collectibility? Buyer-friendly definitions exclude AR over 90 days; seller-friendly definitions include all current AR. The difference can be meaningful.

Inventory valuation

For businesses with significant inventory, the valuation method (FIFO vs. LIFO, write-downs for obsolete inventory) and the diligence-period count can swing the working capital number significantly.

Deferred revenue / customer deposits

In businesses with prepaid customers, are customer deposits a liability (reducing working capital) or essentially a liability the buyer assumes for free? Often a major negotiation point in subscription, services, or project-based businesses.

Cash treatment

Most deals are structured as ‘cash-free, debt-free,’ meaning the seller keeps the cash balance at closing and pays off any debt. But the definition of ‘cash’ (operating cash vs. excess cash vs. customer deposits) needs care.

Best Practices for Sellers

• Track your working capital for 12–24 months before going to market. Know what your normalized monthly working capital actually looks like.
• Negotiate the target carefully in the LOI. Don’t accept a placeholder like ‘to be determined in diligence’ — the target should be specifically defined or formula-driven by the time you sign LOI.
• Use specific, defined accounting principles. The purchase agreement should specify exactly how each line item is measured. Avoid ‘in accordance with past practice’ without specifying what that means.
• Consider a seasonal adjustment. If your business has real seasonality, build it into the target formula rather than fighting about it at the true-up.
• Get a sell-side QofE. Sell-side QofE typically includes a working-capital analysis that identifies the right target before negotiations start.
• Time closing carefully. If possible, close at a point in the cycle when your working capital is naturally around the target level — minimizing the chance of a true-up surprise.