In an M&A transaction, enterprise value is converted to equity value by deducting net debt and then adjusting for any difference between actual and normalized working capital at closing. The peg is typically set as the trailing 12-month average of monthly working capital, which smooths seasonal fluctuations. If the seller delivers working capital above the peg, they receive a top-up; below the peg, they pay a deduction.
NWC normalization requires stripping out items that are not part of recurring business operations: related-party balances, deferred revenue classification disputes, unusual inventory builds ahead of sale, accelerated collections to inflate cash, and delayed payments to suppliers to suppress payables. Buyers look for these patterns specifically — they are among the most common forms of pre-sale financial engineering.
For French and Swiss SMEs, working capital disputes are one of the most frequent sources of post-closing litigation. The amount in dispute is often €200k–€1m — small relative to enterprise value, but large relative to the seller's legal costs. Setting a clearly defined, independently calculated peg in the LOI and SPA, with agreed accounting principles for NWC calculation, is among the most important protective measures a seller can take.
Working capital adjustment at closing
Peg (normalized NWC): €1.5m. Actual NWC at closing: €1.1m (seller collected aggressively and paid suppliers slowly in the final quarter). WC shortfall: €400k. Post-closing adjustment: buyer deducts €400k from deferred payment or escrow. Seller effectively received €18m (headline) minus €400k = €17.6m net. A properly set peg and consistent Q4 operations would have avoided this deduction.
Frequently asked questions
How is the working capital peg calculated?
Most transactions use the trailing 12-month average of month-end working capital — a simple average of 12 monthly snapshots. This methodology smooths seasonal peaks and troughs. Alternatives include a 24-month average (for more volatile businesses) or a specific-date target (for very stable businesses). The calculation methodology, and the accounting policies applied to each line item, must be agreed and documented in the SPA.
What items are typically excluded from NWC?
Cash and debt equivalents (these are handled separately as net debt); deferred tax assets and liabilities; related-party balances; contingent liabilities; items classified as exceptional. The exact exclusion list is negotiated between buyer and seller advisors and forms part of the SPA schedules.
Can a seller prepare for working capital due diligence?
Yes. The key preparation steps are: (1) calculate your own NWC history by month for 24 months before advisors do; (2) identify and remove non-operating or related-party items before analysis begins; (3) do not manage working capital artificially in the months before closing (early collections, delayed payments) as these create the largest closing adjustments; (4) engage a financial advisor to model your expected peg before LOI negotiation.