Buyers spend weeks negotiating the purchase price and then, in the last stretch before close, wave through a clause most of them barely understand. That clause is the working capital peg, and it can move six figures of real cash between buyer and seller after the headline number is locked. The price gets the attention. The peg moves the money.
The peg is a target level of net working capital the seller agrees to deliver on the day the deal closes. Net working capital, for most small deals, is receivables plus inventory minus payables: the short-term operating capital the business needs to keep running. If the seller hands over less than the agreed target, the buyer pays less. If more, the buyer pays more. The mechanism is dull, mechanical, and easy to get wrong, which is exactly why it is worth walking through with real numbers.
Why the peg exists at all
When you buy a business, you are buying a running operation, not a snapshot on a single date. A running operation needs a certain amount of working capital to function: cash to buy inventory before customers pay, receivables in the pipeline, payables that fund part of that cycle. If the seller drains that capital right before close, you inherit a business that cannot make payroll or restock without you wiring in fresh cash on day one. That is money you already thought you paid for.
Left unprotected, the incentive runs one way. A seller can accelerate collections, stop reordering inventory, and stretch payables in the final weeks, walking out with the working capital in their pocket and leaving you an empty tank. The peg closes that door. It says: deliver the business with a normal amount of working capital in it, defined in advance, and we settle any difference in dollars.
The worked example
Meet Cedar Point Distribution, a made-up wholesale distributor. Every figure below is invented to show the mechanics. None of it is a real company or a real deal. What is real is the shape of the calculation.
Cedar Point's net working capital is receivables plus inventory minus payables, measured at each month-end over the trailing twelve months. Here is the full year:
| Month | Receivables | Inventory | Payables | Net Working Capital |
|---|---|---|---|---|
| January | $900,000 | $1,320,000 | $600,000 | $1,620,000 |
| February | $920,000 | $1,350,000 | $620,000 | $1,650,000 |
| March | $950,000 | $1,380,000 | $650,000 | $1,680,000 |
| April | $980,000 | $1,420,000 | $680,000 | $1,720,000 |
| May | $1,010,000 | $1,470,000 | $720,000 | $1,760,000 |
| June | $1,050,000 | $1,540,000 | $770,000 | $1,820,000 |
| July | $1,100,000 | $1,620,000 | $820,000 | $1,900,000 |
| August | $1,170,000 | $1,730,000 | $890,000 | $2,010,000 |
| September | $1,200,000 | $1,800,000 | $950,000 | $2,050,000 |
| October | $1,180,000 | $1,730,000 | $930,000 | $1,980,000 |
| November | $1,050,000 | $1,520,000 | $790,000 | $1,780,000 |
| December | $920,000 | $1,340,000 | $630,000 | $1,630,000 |
| Trailing-twelve-month average (the peg) | $1,800,000 |
The twelve monthly figures add up to $21,600,000, so the average is $1,800,000. That average becomes the peg. Cedar Point's working capital swings from a winter trough near $1,620,000 to a late-summer peak above $2,000,000 as inventory builds ahead of the busy season, which is exactly why one month is a bad basis and the full-year average is a fair one.
Now the close. Say Cedar Point closes in February, when the business is near its seasonal low, and the actual net working capital delivered on the closing date is $1,650,000. The true-up is simple: delivered minus peg. That is $1,650,000 minus $1,800,000, or negative $150,000. The seller delivered $150,000 less working capital than agreed, so the purchase proceeds are reduced by $150,000, dollar for dollar. The buyer keeps that cash to refill the tank the seller ran down.
The mechanism runs both ways. If Cedar Point had instead closed in August and delivered $1,950,000 of working capital, a bit below the $2,010,000 August month-end in the schedule because the close landed mid-month, the true-up would be $1,950,000 minus $1,800,000, or positive $150,000. The seller handed over more than the target, so the buyer pays an extra $150,000. That is not a penalty, it is a refund: the seller funded working capital the buyer would otherwise have had to supply, and the true-up simply reimburses them for it.
Where buyers get burned
The arithmetic is the easy part. The judgment is where deals go sideways.
- Seasonal businesses pegged on the wrong window. Cedar Point's swing is the whole story. Set the peg off a single winter month and the seller can deliver near the low and pocket the difference. Set it off a peak month and the buyer overpays. The trailing-twelve-month average, seasonally adjusted if the close date is far from the mean, is the honest basis.
- Receivables that count on paper but not in cash. The peg treats a dollar of receivables as a dollar of working capital, but a ninety-day-overdue invoice from a shaky customer is not worth a dollar. Aging quality inside the number matters, and it is precisely what a quality of earnings analysis is meant to surface before you agree to the peg.
- Inventory that counts but does not sell. Dead or obsolete stock inflates the working capital figure while being worth far less than its book value. A seller near a soft peg can meet the target with inventory you will end up writing off.
- A purchase-agreement definition that differs from the diligence schedule. If the working capital defined in the legal agreement includes or excludes different accounts than the schedule you built the peg from, the two numbers will not tie, and the argument surfaces at close when leverage is gone. Define the accounts once, in writing, and use the same definition everywhere.
Formula and mechanics summary
The whole thing reduces to two lines. The peg is the agreed normalized net working capital target, commonly the trailing-twelve-month average and seasonally adjusted where the business swings. The closing adjustment is delivered net working capital minus the peg: positive means the buyer pays more, negative means the buyer pays less, settled dollar for dollar.
Two mechanics sit on top of that. A collar is a small band around the peg, say plus or minus a set amount, inside which no adjustment is made, so tiny month-to-month noise does not trigger a settlement. And because the exact closing balance sheet is not final on the closing day, a portion of the price often sits in an escrow holdback for sixty to ninety days while the final working capital is calculated and any true-up is paid out of, or back into, that account. The escrow is what makes the dollar-for-dollar settlement actually enforceable after the wire has already cleared.
Getting the number right before you sign
Everything above depends on one thing: a clean, monthly view of net working capital built from the target's actual accounting records, not a single snapshot from the seller's broker. Zenith computes month-by-month net working capital straight from the target's books, breaks out receivables aging and payables, and produces a suggested peg on a trailing-twelve-month basis with the seasonal swing visible, so you walk into the peg negotiation with your own number instead of arguing off theirs.
See how the diligence workbook computes working capital or work through the due diligence checklist before you sign.
