Resource
Working capital peg and price adjustment guide
How the normalised working capital peg is set and negotiated, how completion accounts and locked box mechanisms differ, and how the purchase price adjustment is calculated, reviewed and disputed.
01
Why a working capital peg exists
A buyer agrees a price on the assumption that the business is delivered with the level of working capital needed to run it. Without a mechanism, a seller could collect receivables early, delay supplier payments and run down inventory before completion, extracting cash while leaving the buyer to fund the shortfall. The peg fixes a normalised level of working capital and adjusts the price for any deviation at completion.
The peg is negotiated, not calculated. Two parties can look at identical data and reach materially different conclusions depending on the reference period, the definition of included accounts and the treatment of seasonality. The analytical work determines the strength of each side's position.
02
Setting the normalised level
The peg is usually derived from an average of monthly working capital balances over a reference period long enough to capture the trading cycle. The mechanics of that average matter as much as the data behind it.
Reference period
Typically twelve months of month-end balances; a shorter window can be justified where the business has structurally changed.
Seasonality
A simple average understates the peg for a business completing at a seasonal peak; consider a monthly target curve instead of a single number.
Growth adjustment
A growing business consumes working capital, so a trailing average understates the requirement at completion. Scale the peg to revenue or use a more recent window.
Non-recurring balances
Strip out one-off receipts, unusual prepayments, exceptional supplier terms and balances relating to disposed or discontinued operations.
Policy consistency
The peg must be set on the same accounting policies that will be used to prepare the completion accounts, or the adjustment will capture a policy difference rather than an economic one.
03
Defining what is in and out
The single most common source of dispute is an account that sits in neither the working capital definition nor the net debt definition — or, worse, in both. The definitions should be drafted together, with a schedule listing every balance sheet line and its assigned treatment.
Normally included
Trade receivables, inventory, trade payables, accrued expenses, prepayments and other current operating balances.
Normally excluded
Cash, borrowings, interest, tax balances and any item already captured as a debt-like item in the net debt calculation.
Judgemental items
Deferred revenue, accrued bonuses, unpaid capital expenditure, provisions, rebates, VAT and intercompany balances — each requires an explicit decision.
Double counting
Any item deducted from price as debt-like must be excluded from working capital, and vice versa; check the two schedules against each other line by line.
04
Completion accounts versus locked box
Under a completion accounts mechanism, the price is provisional at signing and finalised after completion once accounts are prepared as at the completion date. Actual working capital, net debt and sometimes cash are compared to agreed targets and the price is adjusted. It gives the buyer economic risk and reward from completion, but it leaves price open for weeks and creates dispute risk.
Under a locked box, the price is fixed by reference to a historical balance sheet date. The buyer takes economic risk from that date, and the seller is prohibited from extracting value between the locked box date and completion other than through permitted leakage. There is no post-completion adjustment, so certainty is higher — but the buyer must diligence the locked box balance sheet thoroughly, because there is no second look.
Completion accounts
Price certainty is lower; the buyer benefits if the business underperforms between signing and completion. Requires a preparation timetable, review period and dispute procedure.
Locked box
Price certainty is higher; the seller typically receives interest or a ticking fee for the period to completion. Requires leakage and permitted leakage definitions with an indemnity.
Choosing
Locked box suits auction processes and clean carve-outs with reliable recent accounts; completion accounts suit volatile businesses or where the balance sheet date is stale.
05
Calculating the price adjustment
In a completion accounts deal the adjustment is arithmetic once the definitions are settled: the price moves pound for pound with the difference between actual and target working capital, adjusted separately for actual net debt against any assumed level. The discipline is in preparation, not calculation.
Prepare on the agreed basis
Completion accounts follow the hierarchy in the agreement — specific accounting treatments first, then the company's historical policies, then the applicable framework.
Compare to the peg
Actual working capital above the peg increases consideration; below the peg reduces it. Apply seasonality-adjusted targets where agreed.
Net debt movement
Adjust separately for actual completion net debt against the assumed level used to set the headline equity price.
Review and dispute
The receiving party has a defined review window; unresolved items go to an independent expert whose remit is limited to the items in dispute.
Collar or de minimis
Some agreements only adjust beyond a threshold, or cap the adjustment, to reduce dispute cost on small movements.
06
What to test before signing
Most peg disputes are avoidable and originate in drafting rather than in the numbers. Before signing, run the mechanism against real data and see what it produces.
Back-test the mechanism
Apply the drafted definition to each of the last twelve month ends. If the adjustment swings wildly, the definition or the peg is wrong.
Trace the peg
Can every month in the reference period be reconciled to the trial balance and to the diligence databook?
Check the interaction
Do the EBITDA, net debt and working capital definitions in the agreement use consistent language and consistent policies?
Model the downside
What is the cash consequence at completion if working capital lands one standard deviation below the peg?
Discuss an Engagement
If you require support with financial modelling, business valuation or financial due diligence for a live transaction or strategic engagement, we'd be pleased to discuss your requirements.