What is a working capital peg?
A working capital peg is the agreed normal level of net working capital, meaning current assets minus current liabilities with cash and funded debt excluded, that the seller must deliver at closing. When the business closes below the peg, the purchase price falls dollar for dollar. When the business closes above the peg, the seller collects the excess.
The peg exists because the buyer is purchasing an operating company and expects enough receivables, inventory, and prepaid expenses to run it without injecting cash on day one. The concept is fair. The methodology behind the number is where sellers lose money.
Why do buyers wait until after the LOI to set the peg?
Most letters of intent state a price and defer the peg with a phrase such as a normal level of working capital to be mutually agreed. That phrase moves a six-figure negotiation into exclusivity, after the seller has dismissed every competing buyer and the buyer faces no competitive pressure.
Windsor Drake puts the peg methodology inside the letter of intent, next to price, before exclusivity begins. Roughly 1 in 3 signed LOIs fail to close on their original terms, and open peg language is one of the standard channels for that erosion.
The Proprietary Discount is the gap between what a serial acquirer pays in an unbanked bilateral negotiation and what the same business clears in a competitive process. That gap accumulates through mechanical terms like the peg as much as through the headline number, which is why Windsor Drake tracks the gap through The Windsor Drake Proprietary Discount Index.
Which peg methodology should a seller argue for?
Most deals choose among a trailing 12-month average, a seasonally adjusted average, or a point-in-time balance, and each version favors a predictable party. The buyer proposes the version that produces the highest peg, so the seller’s job is to know which version fits the business before the buyer picks one.
| Peg methodology | Who it favors | When to argue for it |
|---|---|---|
| Trailing 12-month average | Neither party in stable businesses; the seller when the close would land at a seasonal peak | The default seller ask, strongest when monthly working capital is stable or the closing date is uncertain |
| Seasonally adjusted average | The party whose normal season the close would otherwise misrepresent | Argue for it when working capital swings materially across the year and the likely closing month is known |
| Point-in-time balance | Whoever controls the reference date, which is almost always the buyer | Accept only when the date is contractually fixed and falls in a month that matches the normal operating level |
The exclusions matter as much as the method. Whether deferred revenue, accrued bonuses, or customer deposits sit inside or outside the calculation can move the peg more than the averaging period does.
How much does the wrong methodology cost a seasonal business?
Take a hypothetical software company that invoices 70 percent of its annual maintenance in the first quarter. Receivables swell in March and drain through the year, so month-end net working capital runs from $1.6M in March down to $0.9M in October, with a trailing 12-month average of $1.2M.
A buyer pegging off the March balance sheet sets the target at $1.6M. A close in October delivers $0.9M of actual working capital, and the seller absorbs a $700,000 price reduction on a business operating exactly as it always has.
A trailing 12-month average peg of $1.2M cuts the same adjustment to $300,000. A seasonally adjusted peg measured against normal October levels cuts it to zero. On this fact pattern the methodology choice alone is worth six figures.
How does the post-closing true-up work?
At closing the parties settle against an estimated balance sheet. Within 60 to 90 days the buyer delivers a final closing statement, the difference between estimate and actual is settled dollar for dollar, and disputed items go to an independent accountant named in the purchase agreement.
Collars soften the mechanic. A collar creates a dead band, for example no adjustment within $50,000 of the peg in either direction, so small variances never trigger payments. Sellers should also push for a cap on downward adjustments; buyers resist caps and usually win the point when no competing bidder is present.
Is deferred revenue debt or working capital?
Deferred revenue is the single biggest peg fight in software transactions. The buyer’s position is that deferred revenue is a debt-like obligation to deliver service customers already paid for, so it belongs in the net debt bridge at or near face value. The seller’s position is that deferred revenue is an ordinary operating liability that recycles every month, costs far less than face value to fulfill, and belongs inside working capital where the peg absorbs it.
Negotiated outcomes span the full range between those positions. Serial software acquirers such as Volaris and Valsoft run this negotiation many times a year; the founder across the table runs it once.
How do buyers use the peg to retrade the price?
The peg is the quietest retrade channel in a deal because it never has to be called a price cut. A buyer that proposes a $400,000 higher peg in week six of exclusivity has cut the price by $400,000 while framing the move as accounting.
The tactic works late in exclusivity, when the seller has spent months of attention and $75,000 to $150,000 of legal budget on a $20M deal and does not want to restart. The pattern belongs to the same family of post-LOI pressure covered across Windsor Drake’s offer-received guides.
What should my accountant prepare before any LOI?
Instruct your accountant to build a monthly net working capital schedule covering at least 24 months, stated on the same basis the purchase agreement will use, with cash, funded debt, and contested items broken out. Add a deferred revenue waterfall showing how balances convert into delivered service.
From that schedule, table your own peg and methodology during the LOI negotiation. The seller who presents a documented peg first anchors the number; the seller who waits negotiates against the buyer’s draft inside exclusivity.
If a buyer’s letter of intent is in front of you and the peg is still an open phrase, Approach Response is the Windsor Drake engagement that fixes the methodology before exclusivity starts.
Questions founders ask
What is a typical working capital peg amount?
No standard amount exists because the peg reflects each company’s normal operating level. The defensible anchor is a trailing 12-month average of monthly net working capital, calculated on the same accounting basis the purchase agreement will use. The methodology, not a benchmark figure, determines whether the peg is fair.
Can the working capital peg be negotiated in the LOI?
Yes, and it should be. The LOI can state the methodology, the exclusions, and even a provisional peg figure. Buyers resist because an open peg preserves a repricing channel inside exclusivity, and buyer resistance to peg language in the LOI is itself information about intent.
Does cash count in the working capital peg?
No in most lower-middle-market deals. Transactions run cash-free and debt-free, so cash and funded debt sit outside the peg and settle separately in the equity value bridge. The fights concentrate on items that resemble both categories, such as deferred revenue and customer deposits.
What happens if working capital at close is above the peg?
The purchase price increases dollar for dollar under a standard two-way adjustment. Sellers should confirm the adjustment is genuinely two-way, because some buyer drafts adjust downward for shortfalls while capping or eliminating upward payments for any excess the seller delivers.
How is deferred revenue treated in the peg for a software company?
Buyer drafts commonly treat deferred revenue as a debt-like item at or near face value, while sellers argue it belongs inside working capital as a recycling operating liability. Negotiated outcomes span the full range between those positions, and the treatment often moves more money than the peg methodology itself.
Who resolves a working capital dispute after closing?
The purchase agreement names an independent accounting firm as arbiter, and its determination on the disputed items is final. The true-up settles within 60 to 90 days of closing in most deals, so disputes surface while escrow funds remain available to satisfy them.
Last reviewed July 28, 2026 by Jeff Barrington, Founder and Managing Director, Windsor Drake. Content on this page may be cited with attribution and a link to https://windsordrake.com/valuation/working-capital-peg/