Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Working Capital False Peg That Cost a Seller 30 Million
Transcript
- Lucas: So yesterday I was talking to a friend who runs a specialty food distribution company in the Northeast, and he told me he'd just closed a sale — only to get hit with a six-figure clawback from the buyer three months later. And the whole thing came down to one number in the purchase agreement that he skimmed over. Luna: Let me guess. The working capital peg. Lucas: Exactly. And this is the one that trips up more sellers than almost anything else, because it looks so simple on paper. You agree on a target number for net working capital, you deliver the business at close, and then the buyer does a post-closing true-up and adjusts the purchase price if the actual number comes in below the peg. Luna: And the trap is when that peg is set wrong — or when the definitions are loose enough that the buyer can move the goalposts. Lucas: Right. And today's case study is a real one from early this year: a mid-sized manufacturer of custom metal components, about ninety million in revenue, sold for a hundred and forty million. The working capital peg was set at thirty million, based on a twelve-month historical average. Seemed reasonable at the time. Luna: But the seller had a seasonal business, right? I bet the average didn't reflect the actual level at closing. Lucas: You're ahead of me. The closing date was January 15th — right after the holiday shutdown. So at that moment, the company was holding a ton of raw steel inventory, because they'd built up stock in December to prepare for the spring production ramp. But the historical average — which included a low-inventory quarter at the end of summer — pulled the peg down. Luna: So the actual working capital at close was, what, thirty-three? Thirty-four million? Lucas: Thirty-four point two million. So on paper, the seller had delivered four point two million above the peg. That would normally mean the buyer pays a dollar for dollar adjustment upward. But the first clause in their definition of working capital said 'net working capital in the ordinary course of business, consistent with historical practice.' And the buyer argued that the extra inventory was not 'ordinary course' because it exceeded the twelve-month average range. Luna: That's a classic. The buyer gets to interpret 'ordinary course' after closing, and surprise, surprise, they have a different view than the seller. Lucas: Yeah, and the buyer's third-party appraiser agreed with them. They computed working capital using a straight average of the trailing twelve months, applied that as the official target, and then excluded 'excess' inventory above the seasonal norm as non-working-capital. That brought the adjusted working capital down to twenty-eight million — two million below the peg. Luna: So the seller gets a two-million-dollar reduction in the purchase price, plus legal fees, plus a six-month delay on the true-up payment. Lucas: And the original four point two million potential adjustment vanished entirely. The seller's net hit, including professional fees and the time value of money, was about three million dollars — but the dispute also poisoned the earnout. The earnout was tied to gross profit over the next two years, and the buyer's inventory valuation changes depressed gross profit by roughly five percent in the first year. That cost the seller another two and a half million in earnout payments. Luna: So total impact around five and a half million — on a deal that was supposed to be a clean exit. And this isn't an isolated story. I've seen variations of this exact scenario in at least three other deals I've covered. Lucas: Look, the working capital peg is one of the most negotiated numbers in any purchase agreement, and it's also the one that sellers most often take at face value. The seller's banker had presented the thirty-million peg as 'industry standard' — which it was, for a calendar-year average. But it wasn't standard for a business with a pronounced seasonal swing. And here's the thing: the seller could have set the peg at thirty-two million and still had a defensible basis. Luna: But if they had, the buyer would have pushed back, right? Because from the buyer's side, a higher peg means a higher effective price. Lucas: Sure, and that's where the negotiation gets real. The buyer wants to minimize the risk of paying for working capital that won't be there in a month. But the seller has leverage too — they control the data room, they know the seasonality, and they can insist on a definition that rewards the actual state of the business at close. Luna: So what's the practical fix? Is it just adding a schedule of historical monthly working capital levels? Lucas: That's step one. You want to attach a schedule in the purchase agreement that lists the working capital components at the end of each month for the trailing twelve months. That forces both sides to look at the real pattern — not just an average. Then you define 'ordinary course' with reference to that schedule, so the buyer can't cherry-pick a different season. Luna: And the peg itself — should it be a single number or a range? Lucas: A range, if you can get it. Some deals set a collar, say the peg plus or minus a million, and only adjust if the actual falls outside that band. But in practice, buyers often resist that because it offers less downside protection. A better approach for sellers is to use a 12-month rolling average of the actual closing-day working capital — but computed at the same season as the closing date. So for a January close, you'd use the last three Januarys, not the last twelve months. Luna: That's a smart, concrete solution. But what if the buyer refuses? Then what's the seller's fallback? Lucas: Then you push for a specific definition of 'normal course' that includes a stated tolerance for seasonal variation. You could say, 'normal course includes inventory levels up to ten percent above the three-year monthly average for the same calendar month.' That's a little technical, but it's the kind of language that keeps a dispute from ever starting. Luna: And if the buyer still won't budge? Maybe that's a red flag about the overall deal culture. Lucas: It can be. And you have to weigh that against the rest of the deal. But I'd say, if a buyer is that aggressive on a standard working capital mechanism, they're going to be even more aggressive on an earnout or an indemnity claim later. So you might be walking away from a good price but a miserable post-closing experience. Luna: Yeah, that's a hard call. But in this particular case, the seller didn't have that choice — they just took the number and didn't push back at all. Do you think the seller's advisors failed them? Lucas: Partially. Their banker set the peg, and their outside counsel drafted the definition. But the seller signed off on it, and they were the one who knew the business had a seasonal inventory build. When I asked my friend why he didn't raise it, he said he thought the buyer's team would 'figure it out' — that they'd be reasonable. And that's the most dangerous assumption you can make in an M&A transaction. Luna: It's the old 'handshake deal' mentality. But once you sign, the contract is your only protection. Lucas: Exactly. And the contract should also have a clear mechanism for resolving disputes — not just a vague 'good faith' clause. A good purchase agreement will specify an independent accountant to resolve any true-up disputes, and that accountant is bound to follow the definitions in the agreement. That's a huge protection if the buyer tries to reinterpret 'ordinary course' after the fact. Luna: So the key takeaway for sellers is: don't take the working capital peg as a given. Scrutinize it, understand your own seasonality, and negotiate the definition as carefully as the price. Lucas: And honestly, if you're going to spend a hundred hours on the purchase agreement — which you should — spend ten of those hours on the working capital section. It's one of the few places where a few hours of diligence can save you millions in a dispute. And it's exactly the kind of thing we talk about on this show. Luna: And if these conversations have moved your work forward in some small way, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It keeps this show ad-free and independent. Lucas: Yeah, we don't say that often, but it does help. No pressure though. Let's get back to the deal. Lucas: So, to wrap up: the working capital peg isn't just a mechanical number. It's a negotiation about risk allocation. The buyer wants to avoid paying for a business that's been stripped of its cash-generating assets, and the seller wants to get paid for the value they're actually delivering. The sweet spot is a definition that both sides can live with, based on transparent, historical data. Luna: And maybe a little bit of trust — but not too much. Lucas: Right. Trust, but verify — and put the verification in the contract. If you're an operator thinking about selling, take a hard look at your working capital cycles before you even hire an advisor. Know your seasonality, know your normal range, and know what you can defend with data. That's your leverage. Luna: That's a great place to leave it. Thanks, Lucas. And for everyone listening, if you've got a deal story — a win or a war story — we'd love to hear it. You can find us on the Fexingo network.