Working Capital: The Part of Your Deal You’re Probably Not Ready For

Ask a business owner who has been through a middle market transaction what caught them off guard, and working capital comes up more often than almost anything else. Not the headline valuation number. Not the due diligence process. The working capital adjustment comes up most often: the post-close calculation that can claw back hundreds of thousands of dollars from sale proceeds if the seller wasn’t prepared for how it works.

Understanding working capital mechanics before you’re in a deal is one of the highest-value things you can do to protect your transaction outcome.

What working capital means in a deal

Working capital in the accounting sense is current assets minus current liabilities, representing the net short-term liquidity of the business. In a deal context, it represents the normalized level of operating liquidity a buyer expects to receive as part of the business they’re acquiring. The concept is simple: if you’re buying a business, you expect it to come with enough working capital to keep operating without an immediate cash injection.

The deal structure almost always includes a working capital “peg”: a target amount of working capital to be delivered at close, usually derived from a historical average (often trailing twelve months). If the actual working capital at close is below the peg, the seller writes a check to the buyer after closing. If it’s above, the buyer pays the difference to the seller. These adjustments are calculated after the deal closes, when the seller has less leverage to dispute the methodology.

Where sellers get hurt

The most common source of working capital disputes isn’t fraud or bad faith. It’s sellers who haven’t thought carefully about what “normal” means for their business and haven’t documented their position going in.

Seasonality is a frequent problem. A business with seasonal revenue patterns might have a working capital level in January that looks very different from its level in September. If the deal closes at the wrong point in the cycle and the peg was set using a simple average, the seller can find themselves delivering working capital that’s legitimately below the target even though nothing has changed about the business.

Deferred revenue is another common issue. How deferred revenue is treated in the working capital calculation, whether as a liability that reduces working capital or excluded entirely, can have a material impact on the adjustment, and buyers and sellers often have different views on the right approach.

Intercompany balances, owner-related receivables or payables, and inconsistent expense accrual practices all create exposure in the working capital calculation that sellers who haven’t done the analysis simply don’t see coming.

What preparation looks like

Sell-side working capital preparation involves building a detailed historical working capital analysis, typically covering three years of month-end data, that identifies the true normalized level for the business, accounts for seasonality, and surfaces the specific accounts and methodologies that are likely to be disputed. It also involves proactively addressing the issues that are going to come up: cleaning up intercompany balances, documenting accrual policies consistently, and preparing a defensible position on any judgment-sensitive items.

The goal isn’t to game the analysis. It’s to show up to the working capital negotiation knowing your numbers as well as the buyer does, and having the data and documentation to support your position.

Working capital analysis is a core part of how we prepare clients for a transaction. Ask us what we typically find.