The Working Capital Trap: Defend Your Purchase Price in a PE Sale

Founders celebrate the LOI and then discover the real battle happens in the purchase price adjustment. A seller’s playbook to defend headline price requires a clean peg, tight definitions, and audit-ready evidence. The most common haircut arrives through the net working capital true up. If the peg is set on a lazy average or the definition is fuzzy, a great headline turns into a smaller wire. You should treat working capital like a mini deal inside the deal.

What buyers mean when they say “working capital”

Keep these five terms in your pocket. They show up in every SPA and they decide money:

  • Net Working Capital (NWC): current assets minus current liabilities, typically excluding cash and debt items.
  • Peg or target NWC: the level you agree the business should deliver at closing.
  • Completion Accounts: post close true up to the peg.
  • Locked Box: no post close true up. Equity value set off a historical date with leakage protections.
  • Debt-like items: obligations that behave like debt and reduce equity value, for example deferred revenue in many software deals, accrued payroll taxes, or customer deposits.

How value leaks without you noticing

Each issue is small on paper, but together they move millions:

  • A straight 12-month average ignores seasonality and growth.
  • Off system discounts and credit memos spike AR dilution after closing.
  • Inventory reserves are optimistic, so a count later reveals a shortfall.
  • Deferred revenue is suddenly labeled debt-like after you shook hands on price.
  • Cut off rules change at the last minute and move invoices across the line.

Numerical Example: The Impact of the Peg

The data decides which story wins. Consider this simple numbers picture:

Metric Value / Scenario
List price 250
Peg proposed (12-month average) 20
True run rate NWC 23
Purchase price adjustment (if delivering 22.5 against 20 peg) -2.5
Outcome with 23 Peg and narrow collar No cash moves

Three models sellers should know

Locked Box

This model is used when books are clean and leakage is controllable. There is no NWC true up. It demands a tight leakage list and covenants on value leakage between the box date and close. This is a good fit for predictable businesses with steady seasonality.

Completion Accounts

This is applied when volatility is real but trending up. In this case, you want a forward looking peg, not a backward average. It is wise to add collars so small swings do not trigger cash movement and pre-agree debt-like schedules and cut off tests.

Hybrid with guardrails

This approach involves Completion Accounts plus a narrow band collar and pre-signed policy memo. An independent accountant may be used to arbitrate quickly on defined policies only.

The Price Defense Map

Think in three lanes: Definition, Evidence, and Mechanics.

1) Definition: write the rules before the game starts

  • Define current assets and current liabilities precisely.
  • List debt-like items on a schedule so they cannot double count later.
  • State that Completion Accounts follow the same policies and materiality as the last audited set.
  • Carve out one time items such as a safety stock build or a temporary vendor prepay.

2) Evidence: show your work so the peg is obvious

  • Provide a 13 month NWC bridge with seasonality callouts and growth annotations.
  • Disclose AR aging with credits and deduction trends and a dispute log for the top twenty customers.
  • Show inventory roll-forward by family with excess and obsolete policy and write down history.
  • Map deferred revenue to delivery obligations and support with cohort retention.

3) Mechanics: reduce drama with small, clear rules

  • Collar: agree a neutral band, for example plus or minus 2 to 3 percent of enterprise value, where no cash changes hands.
  • Cut off tests: lock revenue recognition, unbilled rules, and credit memo timing.
  • No double dip: if an item lowered EBITDA in QoE it cannot also change NWC for the purchase price adjustment.
  • Dispute path: independent accountant resolves within 30 days using the agreed policy memo only.

Buyer plays and seller counters

  • Play: Average peg on the last twelve months.
    Counter: Forward peg using last quarter annualized, adjusted for current customer terms and mix, with a 13 month support file.
  • Play: Late reclassification of deferred revenue as debt-like.
    Counter: Align treatment in the LOI. If treated as debt-like, negotiate offsets for prepayment benefit, low CAC payback, or implementation liabilities already delivered.
  • Play: Off system approvals create post close credit memo spikes.
    Counter: Put discount governance in writing and export approvals from the quoting tool.
  • Play: Stretch AP to flatter cash while the peg is set.
    Counter: Provide vendor aging and service level risks and align on an AP cap relative to historical DPO.