Working Capital Pegs: How Negotiating NWC Can Save You Millions
The technical mechanics of setting a net working capital target at close and how the true-up mechanism works in practice.
Working capital is where deals get re-traded at the finish line. The NWC peg determines how much working capital the seller must leave in the business at close. Get this wrong and you could overpay by millions.
What Is the NWC Peg?
In a cash-free, debt-free (CFDF) transaction, the buyer pays for the enterprise value and expects a "normal" level of net working capital (current assets minus current liabilities, excluding cash and debt) to remain in the business. The NWC peg is the agreed-upon level of normal NWC.
Setting the Peg
The peg is typically set as the trailing 12-month average of NWC, or the average of the most recent 6 months if the business is seasonal. Both sides negotiate which accounts to include and exclude:
Typically included: - Accounts receivable - Inventory - Prepaid expenses - Accounts payable - Accrued liabilities
Typically excluded: - Cash and cash equivalents - Debt and debt-like items - Income tax receivables/payables - Deferred revenue (often debated)
The True-Up Mechanism
At closing, the buyer estimates NWC. After close (usually 60-90 days), the actual NWC is calculated. The difference between actual NWC and the peg creates a dollar-for-dollar purchase price adjustment.
If actual NWC at close is $2M below the peg, the seller owes the buyer $2M. If NWC is $1M above the peg, the buyer pays the seller an additional $1M. This mechanism ensures the buyer isn't subsidizing a seller who stripped working capital before closing.
Common Seller Tactics
- Experienced PE professionals watch for:
- Stretching payables: delaying vendor payments to inflate NWC temporarily
- Accelerating collections: pulling AR forward to boost cash-like positions
- Inventory stuffing: building excess inventory that won't convert to revenue
- Reclassification games: moving items between included and excluded categories
Why This Matters for Deal Returns
A $3M working capital shortfall on a deal with $40M of equity means 7.5% of your equity check is subsidizing the seller. At a 2.5x MOIC target over 5 years, that haircut can reduce IRR by 150-200 basis points.
Interview Angle
"Working capital negotiation is one of the most overlooked areas of deal execution. A well-structured peg and true-up mechanism protects the buyer from overpaying. I would set the peg based on a normalized 12-month average, exclude seasonal anomalies, and ensure a rigorous post-close true-up with a 90-day dispute window."