Without working capital, you will not have enough cash on hand to run the business going forward.
You just closed on a business. The seller promised everything was in good working order. The books looked clean. You did the diligence. But on Day One, you find yourself scrambling—struggling to meet payroll, cover basic expenses, or fund operations.
What went wrong?
It all comes back to one thing: working capital.
Working capital is the difference between a company’s current assets and current liabilities. It’s a measure of short-term financial health and operational efficiency. In small business acquisitions, working capital ensures the buyer receives enough fuel to keep the business running from the moment they take over.
Current assets include things like:
Inventory
Cash and cash equivalents
Accounts receivable
Current liabilities include:
Accounts payable
Rent and taxes payable
Salaries and other short-term obligations
Working Capital = Current Assets – Current Liabilities
This simple formula lies at the heart of every smooth acquisition. But if you don’t calculate it properly—or if it’s not clearly defined in the deal—you risk stalling your business before it even gets going.
Imagine you’re buying a used car.
You agree on a price. The seller tells you it runs fine. You both agree that it will come with a half tank of gas. You pay, drive off the lot—and a mile down the road, the car sputters and stops. There's no gas in the tank.
What do you do?
You probably call the seller and ask why they didn’t hold up their end of the deal. You were promised enough fuel to get home.
This exact scenario plays out in business acquisitions more often than it should. The buyer agrees on a price, but after the deal closes, there isn’t enough working capital—enough “gas”—to operate. That’s when the problems begin.
Working capital isn’t just a balance sheet metric. It has real dollar implications in the deal structure.
If the delivered working capital at closing is less than the agreed-upon target, the buyer may be forced to inject additional personal cash or scramble for a line of credit. Conversely, if the seller delivers more working capital than expected, they may receive an increase in proceeds.
This isn’t theory—it happens in every deal.
“These have real dollars on the purchase price, either favorably or unfavorably,” as Patrick O’Connell explained during the session.
There are multiple ways to approach the calculation. Here are the most common:
This is the most straightforward approach:
Current Assets – Current Liabilities
This method excludes cash and debt from the calculation. The seller keeps any cash in the business and pays off outstanding debt. The buyer receives the rest. This is a common and recommended practice because it avoids tax complications and is easier to understand.
“Cash-free, debt-free is an easy-to-understand concept. It limits the risk that you take on as a buyer.”
Used often in asset sales, this approach includes only particular accounts—like accounts receivable, inventory, and accounts payable. This version focuses on the business’s cash conversion cycle, or how long it takes to turn inventory or receivables into cash.
Want to see the full breakdown of working capital, true-up examples, and real buyer pitfalls?
📺 Watch the complete webinar: “Working Capital: Deep Dive in Small Business Acquisitions”
Hosted by Patrick O’Connell, this session walks through:
Once you’ve chosen your calculation method, the next step is to set a working capital target in your LOI or purchase agreement.
To do this, you need to understand the historical trends of the business. Look at monthly working capital levels over the past year or even the last two to three years. Are there seasonal fluctuations? Does working capital spike during the summer and dip during the winter?
These patterns matter, especially if you're closing at a point in the year when working capital tends to run high.
You can use different averaging methods:
A 12-month average for steady businesses
A 6-month or 3-month average if revenue is increasing
“If a business expects revenues to be higher this year, it wouldn’t be appropriate to use the 12-month average. You might want to use the last 3 to 6 months.”
The key is aligning your working capital expectations with the business’s operating reality.
Even after the deal closes, working capital continues to impact the final economics. That’s where the true-up comes in.
A true-up is a post-closing reconciliation process. You compare the actual working capital delivered at closing to the target agreed upon in the purchase agreement. Based on the outcome, the purchase price is adjusted either up or down.
To protect both sides, the deal should include:
A holdback or escrow amount
A defined true-up window (30, 60, or 90 days post-close)
A collar, which is a tolerance range where no adjustment is made (e.g., ±$10,000)
A $10 million revenue consumer business might generate $600,000 in working capital. These businesses often carry more inventory and accounts receivable, which increases working capital requirements.
“A healthy consumer products business should generate, on average, a non-cash working capital balance that is about 8.5% of sales.”
Construction businesses tend to require more working capital. They experience seasonality, longer project cycles, and sometimes delayed collections. This means they need more cash to operate through slow periods.
In contrast, software companies can have very low or even negative working capital. They don’t carry inventory and may bill subscriptions in advance. In many cases, working capital is excluded from the calculation entirely in these deals.
Working capital is more than just a formula. There are important adjustments that can change the final number:
Remove aged accounts receivable that are unlikely to be collected
Exclude unpaid bonuses or salaries that have been earned but not paid
Remove personal loans or lines of credit not tied to operations
Exclude income taxes or sales taxes owed to the government
These adjustments can lower the working capital target, protecting the buyer from inheriting obligations that don’t support operations.
Define working capital early. Ideally during LOI negotiations.
Use a method that matches the business model.
Understand trends and seasonality. Use multi-year monthly data if available.
Set clear expectations in writing. Define what’s included and excluded.
Protect the deal post-close. Use true-ups, collars, and escrow accounts.
If you’d like to dive deeper into working-capital mechanics, the following articles give practical guidance, real-world examples, and legal context:
“The Working Capital Adjustment in LBOs and M&A: Examples” – Breaking Into Wall Street
A clear primer with step-by-step math that shows exactly how the post-close true-up moves purchase price and seller proceeds. breakingintowallstreet.com
“The Importance of Net Working Capital Targets in M&A Transactions” – JAH Law
Explains why every LOI and purchase agreement needs a well-defined peg, and how lawyers frame the negotiation. jahlaw.com
“Working Capital in Small Business Acquisitions: Insights from Industry Experts” – DueDilio
Focuses on lower-middle-market and micro-SMB deals, highlighting common pitfalls first-time buyers face. duedilio.com
“Net Working Capital in Mergers & Acquisitions” – BDO USA
A Big-Four perspective on setting a neutral peg that reflects true operating needs, with practical examples. bdo.com
Working capital is not just a technicality—it’s the fuel your newly acquired business runs on. Without enough of it, you’ll find yourself on the side of the road, wondering where things went wrong.
Get the calculation right. Define it clearly. Negotiate fairly. Protect yourself with the right structure.
“Fight for working capital in your deals… make sure you get that number correct.”
If you do, you’ll ensure a smoother transition, more predictable operations, and a better chance at long-term success.
Contact us today to learn how we can support your next deal.