The Silent Deal Killer: How Working Capital Adjustments Shift Proceeds in Founder-Led M&A

When founders prepare to sell their business, they almost always fixate on two numbers: the enterprise value headline price and the EBITDA multiple.

But there is a quieter mechanism in the purchase agreement that regularly moves hundreds of thousands of dollars at the eleventh hour: the working capital adjustment.

In the lower middle market, buyers expect to acquire a business on a "cash-free, debt-free" basis. However, they also expect the business to include a "normal" level of working capital—the inventory, receivables, and prepaids needed to run operations on day one without requiring an immediate cash injection.

If you do not manage this mechanism carefully during negotiations, you can easily hand a six-figure discount directly to the buyer at closing.

The Danger of the "Peg"

The baseline for this adjustment is called the working capital target, or the "peg."

The mechanics are straightforward, but brutal: if your actual net working capital on the closing date falls below the agreed-upon peg, the purchase price is reduced dollar-for-dollar.

Example: If your purchase agreement sets the working capital peg at $1.5M, but your actual audited working capital at closing is $1.2M, the buyer will reduce your cash proceeds by $300k—usually clawing it out of an escrow holdback or adjusting the final wire.

Conversely, if you come in over the peg, the buyer pays you more. But buyers rarely agree to an uncapped upside, meaning the risk is almost entirely skewed against the seller.

Two Mistakes Founders Make with the Target

Setting a fair peg is where many founder-led transactions run into trouble. Buyers frequently push for a simple, straight 12-month average. For an entrepreneur, accepting a basic average can be a costly mistake for two reasons:

1. Failing to Account for Seasonality and Growth

A true baseline cannot be a blunt average. It must be built using trailing monthly data that is adjusted for seasonality, customer payment cycles, and recent business growth. In founder-led companies—where monthly closing discipline might be light and financial statements are non-GAAP—determining this true baseline requires rigorous analysis. Defending a properly adjusted peg can easily protect 5% to 10% of total deal value.

2. "Fatting" the Business Before a Sale

Founders often make the opposite mistake by hoarding working capital in the months leading up to an exit. They delay writing off old inventory, let collections drag out, or stack up current assets because it feels conservative.

In reality, doing this artificially inflates your trailing average. You end up locking yourself into an unsustainably high peg that becomes nearly impossible to hit on the closing date, resulting in a steep purchase price reduction. The takeaway: operate the business normally and monitor exactly how each month alters your trailing average.

The Devil is in the Definitions

The dollar target is only half the battle; the exact definitions in the Asset Purchase Agreement (APA) matter just as much.

How the legal document treats specific line items will swing the final calculation materially. You must establish strict boundaries around:

Deferred Revenue: Is it treated as a working capital liability or as debt?

Accounts Receivable: What is the cutoff for aging accounts, and how is the allowance for bad debt calculated?

Inventory Valuation: Is inventory valued at cost, market, or using a specific historical accounting method?

Seemingly minor changes to these definitions can instantly swing the cash value at close by six figures, especially if your business relies on large customer contracts or milestone payments.

The Bottom Line

A successful exit is not just about the headline offer on the Letter of Intent. It is about protecting your equity through the final day of the transition.

At Sierra Pacific Partners, we work with founders of mid-market companies to ensure their businesses are positioned properly, their financials are tight, and their net walk-away wealth is fiercely defended.

If you are exploring strategic options or want to understand what a real exit looks like for your company, let's connect for a confidential conversation.