The clause that quietly moves the price
The purchase price in a signed agreement is rarely the amount that changes hands. Between signing and completion, the working capital adjustment recalculates it, and on a middle-market technology deal that recalculation commonly moves seven figures.
It gets less attention than it deserves because it looks like an accounting mechanism rather than a commercial term. It is a commercial term. A peg set against an unrepresentative period transfers value from one side to the other, and the party who noticed first keeps it.
What the mechanism does
A buyer is paying for a business that can operate the day after completion without an immediate cash injection. That requires a normal level of working capital in the business: enough receivables and inventory to fund operations, net of the payables that fund them.
So the parties agree a target, usually called the peg. At completion, actual working capital is measured. Deliver more than the peg and the buyer pays the excess. Deliver less and the price reduces by the shortfall.
In principle this is neutral. In practice everything depends on how the peg is set and how working capital is defined, and both are negotiable.
Setting the peg
The usual starting point is a trailing twelve month average of net working capital. That is a convention rather than a rule, and it is the right answer only where the business is stable and unseasonal.
Where the business is seasonal, a twelve month average will be wrong on almost any given completion date. A software business that bills annually in January carries a very different balance sheet in February from the one it carries in November. Averaging across that produces a peg that neither reflects normal operation nor the position at completion.
The fix is either a monthly peg that varies with the calendar, or a completion date chosen deliberately, or a peg built from a period that actually represents normal trading. All three are negotiable and all three are worth more attention than they usually get.
Watch also for a peg set during a period when the business was managing cash unusually. Slow paying of suppliers, aggressive collection, or a deliberate inventory run-down before a process all flatter working capital and all inflate the peg the seller then has to deliver against.
What counts as working capital
Every line is negotiable and the definition belongs in the agreement with worked examples attached.
Cash is normally excluded and handled separately under the cash-free debt-free convention. The current portion of long term debt is normally treated as debt rather than working capital. Intercompany balances are eliminated entirely in a carve-out, which sounds obvious and is frequently missed.
Accrued but unpaid bonuses, holiday pay, deferred consideration on earlier acquisitions and any provision that behaves like debt all need explicit treatment. Silence in the agreement means an argument at completion.
Deferred revenue, which is where software deals fight
For a subscription business, deferred revenue is usually the largest single item in dispute and the one most likely to move the number materially.
The seller's position is that deferred revenue represents a service obligation to be delivered, not a cash liability, and that the cash it relates to was collected as part of ordinary trading. Including it as a current liability reduces working capital and therefore the price, which the seller sees as being charged twice for revenue already earned.
The buyer's position is that they will incur real cost delivering that service without receiving further cash, and that the obligation transfers with the business.
Three resolutions appear in practice. Exclude deferred revenue from the working capital definition and address it as a separate price adjustment. Include it but set the peg to reflect historical levels so the mechanism only captures genuine deviation. Or apply a collar so that only movements beyond a threshold adjust the price at all.
None is the correct answer in general. What matters is that the treatment is explicit and that the peg was built on the same basis as the completion accounts.
The other common fight
Accounting policy. The agreement should state that completion working capital is prepared using the same policies, practices and estimation techniques as the historical accounts on which the peg was based.
Without that language a buyer can apply more conservative judgements at completion, increasing bad debt provisions or writing down inventory, and the effect flows straight to the price. This is not usually bad faith. It is what a conservative accountant does absent instruction, and the instruction belongs in the contract.
What to do about it
Model the mechanism before you sign. Take the draft definition and the proposed peg, apply them to the last eight quarter ends, and see what the adjustment would have been on each. If the answer swings widely, the peg is wrong for this business.
Negotiate definitions with worked examples appended to the agreement rather than definitions alone. A numerical example resolves in one page what a paragraph of definition leaves open.
Include a dispute mechanism naming an independent accounting firm, with a defined timetable and an agreed basis for allocating their fees. Most disputes settle once both sides know the referee is real.
Watch working capital during the period between signing and completion, and understand that the buyer is watching it too. Both parties have an incentive to manage the balance sheet in the run-up, and an agreement that anticipates that is better than one that discovers it.
Editorial Team · Published for orientation, not as advice on a specific transaction. Any figure cited is orientation, not a valuation. See market notes.