The Net Working Capital Peg: Why Deals Are Cash-Free Debt-Free, How the Target Is Set, and How the True-Up Works

The net working capital peg is a negotiated target for the receivables, inventory, prepaids, payables, and accruals a seller must leave in the business at closing, most often set from a trailing-twelve-month average so the buyer receives a normally capitalized company. Because most private deals are cash-free and debt-free, the seller keeps the cash and pays off the debt, and the purchase price then adjusts dollar-for-dollar for any difference between actual closing working capital and the peg. Published deal data shows these adjustment mechanisms now appear in more than 90 percent of private-target transactions, up from about half of deals a decade ago.

Owners tend to focus on the headline multiple and meet the peg late, after the letter of intent, when negotiating leverage is mostly spent. That is expensive: the true-up moves real dollars in both directions, and deal-terms researchers call an inaccurate target one of the most common sources of post-closing disputes. What follows describes US private-deal practice. It is educational information, not legal, tax, or accounting advice; consult qualified M&A counsel and advisors on your own transaction.

Why deals are cash-free, debt-free

A cash-free, debt-free (CFDF) deal prices the operating business by itself. The seller keeps whatever cash sits in the company at closing and pays off funded debt (term loans, lines of credit, capital leases, shareholder loans) out of the proceeds. The enterprise value a buyer offers, say five times EBITDA, assumes it is buying operations, not the seller's bank balance or borrowings.

But a business cannot run on earnings power alone. It needs fuel: receivables that will convert to cash, inventory to sell, offset by the payables and accrued expenses of ordinary operations. That fuel is net working capital (NWC): current assets minus current liabilities, with cash and debt carved out for deal purposes. Without a peg, a seller could collect every receivable, run inventory to zero, stretch every vendor, pocket the resulting cash, and hand over a company that cannot make payroll. The peg is the buyer's protection against that, and the true-up is the seller's protection in reverse: deliver more working capital than the target and the price goes up.

What counts as working capital in a deal

Deal NWC is a negotiated definition, not a number your accountant hands you:

Balance-sheet item	Typical deal treatment	Why
Cash and equivalents	Excluded; seller keeps it	The cash-free half of CFDF
Accounts receivable	Included, net of an agreed bad-debt reserve	Day-one fuel the buyer is paying for
Inventory	Included, net of obsolescence reserves	Same, but valuation is judgment-heavy
Prepaid expenses	Included where the buyer gets the benefit	Excluded when tied to seller-only costs
Accounts payable	Included	Ordinary-course obligation the buyer assumes
Accrued expenses (payroll, PTO, warranty)	Included if ordinary course	Recurring operating liabilities
Funded debt and lines of credit	Excluded; paid off at closing	The debt-free half of CFDF
Deferred revenue, customer deposits, accrued bonuses, tax accruals	Negotiated: working capital item or debt-like item	Classification moves price dollar-for-dollar

The last row is where definitional fights live. An item classified as debt-like reduces the purchase price dollar-for-dollar with no offsetting credit in the peg, so buyers push deferred revenue, customer deposits, accrued bonuses, and tax liabilities toward that bucket while sellers argue they are ordinary working capital already baked into the target.

How the peg is set: the trailing-twelve-month average

The standard method averages month-end NWC over the trailing twelve months (TTM) and then normalizes the result. A full-year window mitigates seasonality: a distributor that builds inventory in the fall and collects receivables in January would produce a misleading peg if measured from any single month. Deals sometimes use a shorter window, such as six months, when growth means a full-year average understates current needs; seasonal businesses sometimes tie the peg to the expected closing month.

Normalization adjustments

The raw average almost always gets adjusted before it becomes the peg:

• One-time distortions removed. An unusually large customer prepayment, a temporarily stretched vendor, or a bulk inventory buy ahead of a supplier price increase gets backed out or normalized.
• Consistent reserve policies applied. Bad-debt and inventory reserves are restated on one methodology across all twelve months so the average and the closing calculation are comparable.
• Non-operating items stripped. Related-party receivables, personal expenses run through the company, and anything the buyer is not acquiring come out.

Suppose a $12 million deal where monthly NWC over the TTM ranged from $1.5 million to $2.1 million and averaged $1.85 million. Normalization removes a $50,000 owner loan receivable, and the parties set the peg at $1.8 million, documented in an illustrative calculation exhibit attached to the purchase agreement.

Closing-date true-up mechanics, step by step

Nobody knows the exact balance sheet on closing day, so the adjustment happens twice: an estimate at closing and a true-up afterward.

1. The pre-closing estimate. A few days before closing (three to five is typical), the seller delivers an estimated closing balance sheet. The wire at closing adjusts for the estimate against the peg. In our example, an estimated NWC of $1.95 million against a $1.8 million peg adds $150,000 to the closing payment.
2. The buyer's closing statement. Sixty to ninety days after closing is the typical window for the buyer, who now controls the books, to deliver its calculation of actual NWC as of the closing date.
3. Seller review and objection. The seller gets a contractual window to review and object with specificity. Undisputed amounts settle; disputed items go to negotiation.
4. The independent accountant. Items still unresolved go to an independent accounting firm acting as an expert in a non-judicial process, ruling only on the disputed items, with a binding determination. This machinery moves fast by litigation standards: published data shows contested adjustments resolving in under two months on a median basis.
5. Settlement. The final figure adjusts the price dollar-for-dollar. A shortfall is paid to the buyer, often out of a dedicated working capital escrow (median size around 1 percent of transaction value in published studies); a surplus is paid to the seller.

Continuing the example: 75 days after closing, the buyer's statement shows actual NWC of $1.62 million, a $330,000 shortfall against the estimate. The components: a $150,000 reserve against receivables more than 90 days old, a $120,000 write-down of slow-moving inventory, and $60,000 of newly accrued bonuses. The seller accepts the bonus accrual, negotiates the receivable reserve down to $70,000 after two customers pay, and sends the inventory question to the accountant, who splits it. Real true-ups look exactly like this: a stack of judgment calls, each worth five or six figures.

In one study of more than 1,500 private-target deals, buyers' initial adjustment claims averaged about 0.9 percent of transaction value, roughly a quarter of claims exceeded 1 percent, buyers' proposed calculations were ultimately accepted in about 7 of 10 adjustments, and claims and seller-favorable surpluses occurred with nearly equal frequency in recent deals. The true-up is not a formality and it is not one-sided.

Where the disputes actually happen

The true-up compares two balance sheets prepared by parties with opposite incentives, and the judgment calls cluster in three places.

Accounts receivable collectability

The buyer inherits the aging report and applies its own view of what will collect. If the agreement says only "reserves consistent with past practice" and past practice was informal, the buyer has room to build a much larger reserve at closing than the seller ever carried. The fix is a formula in the agreement itself, for example an agreed reserve treatment for receivables past a stated age, applied identically in the peg and the closing statement.

Inventory valuation

Inventory disputes come in two flavors: existence and value. The agreement should say whether a physical count happens at closing and who observes it. Value is harder: obsolescence and slow-moving reserves, costing method, and treatment of variances all involve judgment, and a buyer applying a stricter reserve policy after closing can manufacture a shortfall. Line-item methodology in the working capital exhibit is the defense.

Accrued liabilities and debt-like recharacterization

Accrued PTO, bonuses, warranty obligations, deferred revenue, customer deposits, and tax accruals generate two fights. First, completeness: buyers comb for liabilities the seller never booked. Second, classification: a buyer who recharacterizes an accrual as a debt-like item converts it from a working capital component, already reflected in the peg, into a straight price deduction. The purchase agreement should name these items and assign each one a bucket before signing.

Underneath all three sits the accounting-hierarchy clause. "GAAP applied consistently with past practices" sounds harmless, but it contains a contradiction whenever past practice deviated from GAAP (generally accepted accounting principles), which is common at founder-owned companies. The agreement should state which standard controls when they conflict, and the illustrative exhibit should show the intended answer with real numbers.

How sellers protect themselves

• Model the peg before the LOI. The peg is economics, not paperwork. Calculate your own TTM average and propose adjustments while you still have competitive tension.
• Attach the exhibit. An illustrative calculation showing every included account and every reserve policy, agreed at signing, eliminates most methodology disputes.
• Specify reserve formulas line by line. Receivable aging reserves, inventory obsolescence rules, and accrual practices belong in the agreement, not in "past practice."
• Negotiate a collar. A deadband (for example, no adjustment unless the difference exceeds a set dollar amount) keeps immaterial noise from turning into a claim.
• Contain the downside. A dedicated working capital escrow as the exclusive source for the adjustment, sized near published medians, keeps a true-up claim from reaching your other proceeds.
• Keep access rights. You will need the books and the accounting staff to contest a closing statement; the agreement should guarantee post-closing access.
• Clean up early. Collect aged receivables, write off dead inventory, and book honest accruals at least a year out, because the twelve months before your deal are the months that set your peg.

The bottom line

The peg is where a headline price becomes a real wire amount. Sellers who calculate their own TTM average early, pin down the methodology in an exhibit, and contain the adjustment with a collar and a dedicated escrow rarely get hurt by the true-up; sellers who leave it as boilerplate hand the buyer a second negotiation after the leverage is gone. Bankerly.ai builds working capital analysis into sell-side preparation for this reason; whoever prepares your deal should do the same before the LOI is signed.

Sources

• SRS Acquiom: M&A Working Capital Purchase Price Adjustment Study 2026
• DealLawyers.com: Post-Closing Adjustments: SRS Acquiom Issues Working Capital PPA Study
• SRS Acquiom: Purchase Price Adjustments (PPA): The Net Working Capital Target
• EisnerAmper: Net Working Capital and Key Considerations for Buyers and Sellers Contemplating a Transaction
• Schneider Downs: Understanding the Net Working Capital Peg in M&A Transactions
• Whiteford, Taylor & Preston: Net Working Capital & Purchase Price Adjustments In M&A Deals