In middle market deal making, it’s easy to focus on headline valuation metrics—EBITDA multiples, synergies, and top-line growth. But too often, buyers overlook Net Working Capital (NWC); a critical component that directly impacts post-close liquidity and purchase price.
Get it wrong, and you might find yourself injecting unexpected cash into the business post-close. Get it right, and you’ll avoid unpleasant surprises—and maybe even walk away with a better deal.
What Is Net Working Capital?
Net Working Capital, in M&A terms, isn’t just “current assets minus current liabilities.” In a debt-free, cash-free transaction, the seller retains all cash and is responsible for paying off any debt-like liabilities before closing. The buyer, in turn, expects the business to be delivered with a normal level of operating liquidity i.e. normal level of working capital.
In simple terms, it is the amount of funds required by an organization to meet its day-to-day expenses without the infusion of outside capital. An analogy often used to explain NWC in M&A is the buying a car analogy. Think of buying a business as buying a car; when you buy a card you expect the seller to fill the tank with a reasonable amount of gas. If you don't get enough fuel at close, you're on the hook to top it off.
What is NWC Peg?
In M&A transactions, the Net Working Capital (NWC) peg is a contractually agreed benchmark representing the amount of working capital expected to be delivered at closing. It’s distinct from the NWC target, which is a preliminary estimate based on historical performance and used to guide negotiations. The peg is typically based on normalized historical averages—adjusted for seasonality and non-operating items—and is finalized in the purchase agreement.
At closing, the actual NWC is compared to the peg, triggering a purchase price adjustment on a dollar-for-dollar basis. The below table illustrates the impact of new working capital on the purchase price in a debt-free cash-free transaction.
Best Practices for Acquirers
Start Early—Even Before the LOIA vague or back-loaded peg negotiation benefits no one. By the time due diligence begins, buyers should already have a clear definition of net working capital, a draft methodology for calculating the peg, and a solid understanding of any industry-specific working capital dynamics. Taking these steps early allows your advisors to guide you more effectively and help set a peg that aligns with the operational needs of the business and protects against surprises at closing.
Don’t Blindly Trust the TTM Average
While it’s common to base the working capital peg on a 12-month trailing average, that approach isn’t always fair—or accurate. Instead, analyze the actual cash needs required to support operations at closing and adjust the peg accordingly.
Consider these nuances:
High-growth businesses often require more working capital than a historical average suggests, due to increased receivables and inventory needed to support growth.
Seasonal businesses can be misvalued depending on the timing of close. A deal closing during a seasonal low could understate working capital needs, while a peak-season close could overstate them.
Recently restructured companies may have distorted working capital trends. A thoughtful, bottoms-up analysis is essential to establish a peg that reflects current operations rather than outdated patterns.
Don’t Take the Balance Sheet at Face Value: Scrub It
In every deal, a shallow review of the balance sheet can leave serious value on the table. Your financial diligence should dig deeper—because every adjustment impacts the working capital peg and, ultimately, the purchase price.
Watch for these red flags:
Aged or uncollectible receivables that inflate current assets
Obsolete inventory not properly reserved or written down
Deferred revenue or customer deposits inconsistently applied or excluded
Intercompany and related-party balances that won’t remain post-close
Prepaids or accruals that distort economic reality
These aren’t just accounting footnotes—they’re potential price adjustments. Make sure your diligence team is scrubbing these accounts with precision.
Know Your Accounting Basis: Accrual vs. Cash
Most deals define Net Working Capital on an accrual basis, which reflects true economic activity. If the seller uses cash accounting, key items like unpaid liabilities or unbilled revenue may be missing—skewing the peg and causing unfair adjustments. To avoid this, convert financials to accrual during diligence and ensure the purchase agreement clearly reflects that methodology.
Use a Collar—When It Makes Sense
In transactions involving stable businesses, it may be appropriate to implement a working capital collar—a defined range around the NWC peg within which no post-closing adjustment is made. This approach can streamline the reconciliation process, reduce legal and advisory costs, and support a more collaborative buyer-seller relationship. However, care should be taken to ensure the collar is not so broad that it obscures meaningful financial risks Cash vs accrual accounting
For mid-market acquirers, understanding and negotiating NWC accurately is a deal-critical skill. It ensures post-close stability, reduces the risk of disputes, and protects your return on investment.
At O’Connell Advisory Group, we believe you shouldn’t leave money on the table—or worse, find yourself putting it back in after the fact. If you’re acquiring a business, bring working capital to the forefront early. Your future self will thank you.
A Word of Caution: Working Capital Isn’t Purchase Price
Buyers should view the working capital true-up as a funds flow mechanism, not a backdoor to renegotiate price. The goal isn’t to “win” the peg—it’s to ensure the business runs smoothly on Day One without needing a capital injection.
Bottom Line: Focus on the Fundamentals
For mid-market acquirers, understanding and negotiating NWC accurately is a deal-critical skill. It ensures post-close stability, reduces the risk of disputes, and protects your return on investment.