Every M&A purchase agreement has to answer an awkward question: what stops a seller from draining cash out of the business, or letting inventory and receivables run down, in the weeks between signing and closing? The answer, in almost every deal, is the working capital peg.
What Is a Working Capital Peg?
A working capital peg (sometimes called the "target" or "normal" working capital level) is a dollar figure written into the purchase agreement that represents the amount of net working capital the target company is expected to have on hand at closing, based on its historical average. It isn't an arbitrary number — buyers and sellers typically negotiate it off a trailing 12-month average of the target's actual net working capital, precisely so neither side can cherry-pick a favorable month.
The peg matters because enterprise value is meant to reflect a business that keeps running normally after the deal closes — with enough receivables, inventory, and payables in place to operate without an immediate cash injection from the buyer. If the seller quietly collects all outstanding receivables and stops restocking inventory before closing, the buyer inherits a business that looks the same on paper but is actually starved of working capital.
Why Both Sides Care About the Peg
From the seller's side, the working capital peg protects against being blamed for a business that was always somewhat cash-hungry — the peg is set at a "normal" level, not zero. From the buyer's side, it protects against inheriting a business that has been stripped of the working capital needed to operate. Because the incentives point in opposite directions right up until closing, working capital pegs are one of the most heavily negotiated mechanics in a purchase agreement, and they remain one of the most common sources of post-closing disputes between buyer and seller.
How the True-Up Works
At (or shortly after) closing, the buyer prepares a closing working capital statement showing the target's actual net working capital. That figure is compared to the peg:
- If actual working capital comes in below the peg, the purchase price is reduced dollar-for-dollar — the seller effectively took cash out of the business that the buyer was counting on.
- If actual working capital comes in above the peg, the purchase price is increased — the seller left more working capital behind than promised, and is compensated for it.
This adjustment sits on top of the standard enterprise value to equity value bridge (adding cash, subtracting debt), so a full purchase price calculation involves both steps in sequence. For a complete worked example with real numbers — including the equity purchase price bridge and the true-up itself — see Working Capital Peg in M&A.
Why the Definition of "Working Capital" Matters as Much as the Peg
Interviewers and experienced dealmakers both know that the peg number itself is only half the story. The purchase agreement's precise definition of what counts as working capital — usually excluding cash, debt, and debt-like items — determines what actually gets compared to the peg. A vague or inconsistent definition is the single biggest driver of post-closing disputes, which is why buyers and sellers often spend as much negotiating time on the definition as on the peg amount itself. If you want a broader refresher on working capital mechanics before diving into the M&A-specific version, see Working Capital Deep Dive.
Understanding the working capital peg is a good example of a concept that sits at the intersection of accounting and deal structuring — exactly the kind of topic that comes up in M&A due diligence interviews and case studies.