What is a working capital adjustment?
A working capital adjustment is a mechanism in a purchase agreement that trues up the price after closing based on how much net working capital — receivables, inventory, and payables, broadly — the business actually has on the closing date versus an agreed normal level. If the company is delivered with less working capital than the target, the buyer pays less; if more, the buyer pays more.
The purpose is fairness. Most deals are priced on a cash-free, debt-free basis, with the assumption that the business comes with a normal amount of working capital to keep operating. Without an adjustment, a seller could quietly drain working capital before closing — collect receivables early, delay paying suppliers, run down inventory — and hand over a business that needs an immediate cash injection. The adjustment neutralizes that by holding the seller to a benchmark.
That benchmark, the target or peg, is usually set at the average working capital the business has carried over a recent period, on the logic that it represents the normal level needed to run operations. Setting the peg is one of the more technical negotiations in a deal, because it directly shifts value between the parties.
How the adjustment works
The mechanism runs in a defined sequence around closing:
- Agree the target. The parties set a working capital peg, typically the trailing average, and define precisely which accounts are included — the definition matters as much as the number.
- Estimate at closing. At close, the seller delivers an estimated closing balance sheet, and the price is adjusted preliminarily against the peg.
- True up afterward. Within a set window after closing, an actual closing balance sheet is prepared and the final working capital is calculated, producing a payment one way or the other to settle the difference.
- Resolve disputes. If the parties disagree on the final figure, the agreement usually routes the dispute to an independent accountant whose determination is binding.
Because the adjustment turns on definitions and timing, the precise drafting of the working capital clause is where much of the real money is made or lost — long after the headline price is agreed.
Why working capital adjustments are negotiated so hard
The adjustment looks like plumbing but moves real value, so both sides fight over its details. The level of the peg is a direct transfer: a higher target requires the seller to deliver more working capital for the same price, effectively reducing what the seller keeps. The definition of which accounts count — whether certain accruals, prepaid items, or near-cash balances are in or out — can swing the final number meaningfully.
The classic tension is the seller's incentive to manage working capital downward before closing against the buyer's interest in receiving a fully functioning business. A well-drafted adjustment with a fair peg and a clear definition removes the incentive to game the balance sheet; a vague one invites disputes that surface only in the post-closing true-up, when the leverage has shifted and the lawyers are already involved.