Working Capital Peg in a Service-Business Sale: The Closing-Price Math

You agree to sell the business for $5 million. Then the buyer says the company delivered $180,000 less working capital than promised and reduces the closing payment.

Nothing happened to the valuation multiple. EBITDA did not change. The buyer did not reopen the headline price. The reduction came from a separate piece of the deal: the working capital adjustment.

This is where owners discover that enterprise value and cash received at closing are not the same number.

What a working capital peg actually does

A buyer expects to receive an operating business, not an empty legal entity that needs an immediate cash injection to make payroll and pay suppliers.

The working capital peg is the agreed target amount of operating working capital the seller is expected to deliver. At closing, actual working capital is compared with that target.

The simplified adjustment is:

Working capital adjustment = closing working capital − working capital peg

• A positive result can increase the amount paid to the seller.
• A negative result can reduce the amount paid or create an amount owed after closing.

Actual purchase agreements are more detailed. They define which accounts count, which accounting policies apply, whether a collar or threshold exists, who prepares the closing statement, how long each party has to object, and how disputes are resolved.

Public acquisition agreements filed with the SEC show both estimated closing adjustments and later true-ups after the final closing balance sheet is prepared. The mechanism is not theoretical; it is contractual purchase-price math.

What counts as working capital in a service business

The ordinary accounting definition—current assets minus current liabilities—is only the starting point. The purchase agreement controls the deal calculation.

A service-business schedule may include:

Operating current assets

• Trade accounts receivable, net of an agreed bad-debt reserve.
• Unbilled receivables or earned work in progress, if the agreement includes them.
• Prepaid operating expenses.
• Other specifically defined operating current assets.

Operating current liabilities

• Trade accounts payable.
• Accrued payroll and payroll taxes.
• Accrued bonuses, commissions, or paid time off where included.
• Deferred revenue or customer deposits where included.
• Other specifically defined operating accruals.

Cash and debt are often handled outside the working capital calculation in a cash-free, debt-free transaction. Income-tax balances, transaction expenses, shareholder accounts, and unusual liabilities may also receive separate treatment.

Do not assume an account is included merely because it is current on the balance sheet. The definition, schedule, and accounting rules in the transaction documents decide.

A worked closing example

Assume a service business signs a deal with a $400,000 working capital peg.

The following numbers are hypothetical:

Included account	Closing balance
Trade accounts receivable	$590,000
Less: agreed bad-debt reserve	($35,000)
Included prepaids	$25,000
Trade accounts payable	($105,000)
Accrued payroll and commissions	($95,000)
Closing working capital	$380,000

The calculation is:

$380,000 closing working capital − $400,000 peg = $20,000 shortfall

If the agreement adjusts dollar for dollar with no collar, that shortfall reduces the purchase price by $20,000.

Now assume the seller's pre-closing estimate showed $430,000, so the closing payment initially included a positive $30,000 estimate. Sixty days later, the buyer prepares the final statement at $380,000.

The post-close true-up is $50,000 against the seller: the final result moved from $30,000 above the peg to $20,000 below it.

That is why the closing estimate must be treated as a forecast, not a victory. The final accounting can still move the proceeds after the transaction closes.

How the peg is set

There is no universal period or formula that fits every company. A trailing average is common, but the correct analysis depends on the business and the negotiated documents.

The seller and buyer should examine:

• Monthly working capital over an appropriate historical period.
• Seasonality in billing, collections, payroll, and supplier payments.
• Revenue growth or contraction that makes an old average stale.
• One-time receivables, overdue balances, or unusual accruals.
• Changes in billing terms, deposits, or payment cadence.
• Acquisitions, discontinued services, or other changes in the operating model.
• Consistency between the historical calculation and the closing calculation.

Kreischer Miller's M&A guidance describes pegs based on historical working-capital levels and illustrates why the target protects both sides: the buyer receives enough operating capital, while the seller is not required to leave an unlimited amount behind.

The word “average” can hide a poor result. If a growing company uses a simple trailing average while receivables and payroll have risen sharply, the target may be too low for the buyer's day-one needs. If one unusually slow collection month is allowed to inflate the average, it may be too high for the seller.

The calculation has to explain the operating cycle, not merely average a column.

Before changing the plan, find the real constraint. A free 20-minute Profit & Tax Leak Check helps identify which financial issue is costing the business the most and what deserves attention first.

Five service-business accounts that cause disputes

1. Unbilled work in progress

A law firm, agency, consultancy, or architecture firm may have completed work that has not yet been invoiced. Whether that work is an asset for the peg depends on how revenue is recognized, whether the amount is collectible, and what the agreement includes.

If WIP is included, aging and realization matter. One hundred thousand dollars of time recorded is not necessarily one hundred thousand dollars collectible.

2. Deferred revenue and customer deposits

The cash may already be in the bank, but the buyer still has to deliver the service. The deposit can therefore behave like an operating liability or a debt-like item depending on the agreement and deal structure.

This needs to be resolved explicitly. Treating the cash as the seller's while leaving the buyer with the delivery obligation creates an obvious economic mismatch.

3. Accrued payroll, bonuses, and commissions

Service businesses are labor businesses. A closing date immediately before payroll can show a different liability position from a closing date immediately after it.

The schedule should capture the expense economically incurred through closing, not merely the cash paid by that date.

4. Old receivables

Accounts receivable should be examined by age and collectability. A $200,000 invoice that has been disputed for six months should not be treated like a current invoice expected next week.

The bad-debt methodology matters as much as the gross receivable balance.

5. Related-party and owner balances

Shareholder receivables, personal expenses, intercompany balances, and non-operating accruals can distort the schedule. They should be identified early and treated consistently with the agreement.

This is one reason clean financials before a sale matter beyond the EBITDA calculation. The balance sheet also has to survive diligence.

What the seller should prepare before the LOI

The worst time to build the working capital schedule is after the buyer has proposed the target.

Prepare these items before the letter of intent is final:

1. A monthly working capital calculation for at least one full operating cycle.
2. A written definition of every included and excluded account.
3. Receivable aging tied to the general ledger, with disputed and doubtful balances identified.
4. WIP aging and realization history where unbilled work is material.
5. Deferred-revenue and deposit schedules tied to remaining delivery obligations.
6. Accrued payroll, commission, bonus, leave, and contractor liabilities.
7. A bridge explaining one-time, seasonal, and growth-related movements.
8. A forecast of expected working capital on the proposed closing date.

Then run the buyer's likely definition against the seller's proposed definition. The argument is easier to resolve while there is still time to negotiate the LOI and purchase agreement.

The quality-of-earnings process should also be coordinated with the peg analysis. A normalization used to support EBITDA cannot contradict the accounting treatment used in working capital without a clear explanation.

The tax calculation is separate

The working capital adjustment changes transaction consideration, but the tax result depends on the structure of the sale and how consideration is allocated.

The IRS explains that a business sale generally involves multiple assets and that buyer and seller must allocate consideration among those assets under the applicable rules. Working capital, purchase-price adjustments, installment consideration, and asset allocation should therefore be reviewed together by transaction counsel and tax advisers.

This article explains the financial mechanism. It is not a substitute for the purchase agreement, legal advice, valuation advice, or transaction-specific tax advice.

The owner-level takeaway

Do not negotiate only the multiple.

Ask four questions before treating the headline price as proceeds:

1. What exactly is included in working capital?
2. How is the peg calculated and normalized?
3. What is the expected closing adjustment under the current forecast?
4. What happens during the post-close true-up and dispute process?

Bennett's fractional CFO services and CFO-led exit planning connect those questions to the rest of the transaction: reliable books, normalized earnings, cash forecasting, tax structure, and the decisions that have to happen well before closing.

Sources

• Kreischer Miller: Why the Working Capital Peg Is Important in M&A Transactions
• SEC-filed purchase agreement with estimated and post-closing working capital adjustments
• IRS: Sale of a Business

If a sale is still a few years away, the Profit & Tax Leak Check can identify the financial-structure issues that would make diligence, valuation, or the eventual working capital negotiation harder than it needs to be.