What Every Founder Should Know About Net Working Capital in M&A

Net working capital is one of the most commonly misunderstood components of an M&A transaction. Founders tend to focus on enterprise value, and rightfully so, but the number that actually lands in your account at closing is shaped by several adjustments beyond that headline figure. Working capital is one of the most significant.

At Sampford, we work through working capital mechanics on every deal we run. It's a topic that deserves more attention than it typically gets at the outset of a transaction, so here's a clear breakdown of how it works and why it matters.

Where Working Capital Fits Into the Purchase Price

Most M&A transactions are structured on a "cash-free, debt-free" basis with a "normal" level of working capital delivered at closing. This means the enterprise value agreed in your LOI is just the starting point. From there, the equity purchase price is adjusted for cash on hand, debt and debt-like items, transaction expenses, and the working capital adjustment. Each of these can move the needle materially.

What Working Capital Actually Is

Working capital, in the context of an M&A transaction, represents the operating liquidity required to run the business. It's essentially what the buyer needs on day one to keep the company running the way it has historically.

The calculation is straightforward: current operating assets minus current operating liabilities. On the asset side, this typically includes accounts receivable, prepaid expenses, and inventory. On the liability side, it includes accounts payable, accrued expenses, deferred revenue, and similar items. Cash, debt, and transaction expenses are carved out and handled separately.

Why Working Capital Pegs and Adjustments Exist

Without a working capital mechanism in place, a seller could drain the business of liquidity before closing. Think collecting receivables early, delaying payables, or drawing down inventory. The buyer would then be left injecting capital post-close just to keep operations running. The working capital peg and adjustment mechanism exists to prevent that.

The peg represents the "normal" level of working capital, typically calculated as a trailing 12-month average. At closing, if the actual working capital delivered exceeds the peg, the purchase price increases by the difference. If it falls short, the price decreases accordingly. The adjustment is designed to be net neutral, ensuring continuity rather than creating winners or losers.

Negotiation Considerations for Sellers

Working capital negotiations happen across multiple dimensions, and sellers who engage early and thoughtfully tend to fare better. A few principles worth highlighting:

Establish the methodology at the LOI stage. The specific peg amount is rarely locked in at that point, but agreeing on the calculation method early, including which accounts are in scope and which average period applies, sets the frame for everything that follows.

Classification matters enormously. Each balance sheet item must land in exactly one bucket: cash, debt-like, transaction expenses, or working capital. Items classified as working capital are compared against a historically-based peg rather than reducing your proceeds dollar-for-dollar. That distinction has real consequences.

Push back on debt-like treatment where you can. Certain items sit in a grey zone where buyers will argue for debt-like treatment, which is a direct dollar-for-dollar reduction in price. These commonly include accrued bonuses, vacation pay, commissions, deferred revenue, and capital leases. Sellers should push to have as many of these included in working capital as possible. The difference in outcome can be significant.

Negotiate the peg period in your favour. Whether the peg is based on a 3-, 6-, 9-, or 12-month average can shift the number meaningfully depending on your company's seasonality and growth profile. Sellers generally benefit from a lower peg, so understanding how each option plays out with your actual financials is important groundwork before you get to the table.

Key Takeaways

Working capital is a technical topic, but the implications are very practical. A few things to keep in mind as you approach a process:

The headline enterprise value is not your take-home number. Working capital, debt-like items, and transaction expenses all shape what you actually receive. Understanding the mechanics early puts you in a far stronger position to negotiate effectively.

Definitions drive outcomes. Vague purchase agreement language around working capital components creates risk. The more precisely the SPA defines what's in and what's out, the less room there is for post-closing disputes.

The working capital true-up happens after closing. The closing statement is typically an estimate, with a final true-up completed once actual financials are prepared. Escrows or holdbacks are commonly used to settle any difference, so the conversation isn't fully over at signing.

Work with advisors who have been through it before. The mechanics of working capital negotiations are well-trodden ground for experienced M&A practitioners, but they can catch founders off guard. Having advisors who understand the nuances and can model out the real dollar impact of competing classification approaches is genuinely valuable.

If you're thinking about a transaction and want to understand how working capital and other purchase price mechanics apply to your specific business, we're happy to talk through it.