Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Working Capital Peg Trap That Cost a Seller 22 Million
Transcript
- Lucas: So this week on the Acquisition Talk — the working capital peg. It's a single line in most purchase agreements, but as one seller learned the hard way, it can move twenty-two million dollars. Luna: Twenty-two million — that's not a rounding error. What happened? Lucas: Right. So picture a mid-market industrial distributor — let's call them Summit Supply — doing about eighty million in revenue. They sold to a private equity firm in the summer of twenty twenty-five. The headline price was one hundred and fifty million, clean number, all cash at closing. But the purchase agreement had a working capital peg set at the trailing twelve-month average. Luna: That sounds standard enough. What went wrong? Lucas: Standard, yes, but the devil is in the definition. The seller and the buyer agreed on the peg number — around fourteen million — but they never clearly defined which balance sheet items counted as working capital. Specifically, whether cash and debt were included, and more importantly, how inventory was valued. Luna: Inventory valuation. That's where these things usually get messy. Lucas: Exactly. Summit carried a lot of slow-moving stock. The seller valued it at cost, which was fine in their world, but the buyer's accounting firm applied a lower of cost or net realizable value test. That alone shaved off about seven million from the closing net working capital. Luna: So the buyer says, 'We agreed on fourteen million, but your actual working capital is only seven.' And then what? Lucas: Then the buyer applies the peg adjustment. If closing working capital is below the peg, the purchase price goes down dollar for dollar. So Summit's one-fifty gets cut by seven, down to one-forty-three. But that was only the first hit. Luna: There's more. Lucas: There's more. The real problem was the timing. The buyer's post-closing statement used the actual closing date, which was the first day of the company's slow season. Summit was in the middle of a big inventory build — they had received millions in new stock just before closing, but they hadn't paid for it yet. So their accounts payable were high, and the inventory hadn't turned into cash. Luna: So the working capital number was artificially low because of the seasonality. Lucas: Right. The seller's team had been so focused on hitting the revenue and EBITDA targets that they forgot to look at the cash conversion cycle. The buyer, though, had modeled this. They knew exactly when to close the deal. Luna: Ouch. So the seller gets hit twice — once on the inventory valuation, once on the timing. Lucas: That's right. The final working capital came in at just under five million, so the total adjustment was nine million. But then the buyer also threw in a working capital true-up every quarter for the first year, and that's where another thirteen million disappeared. Luna: Wait, a true-up that costs the seller money? I thought those were for balancing out at closing. Lucas: Usually, yes. But in this deal, the buyer insisted on a mechanism that tied the final purchase price to the average working capital over the next four quarters. If the company didn't maintain that level, the seller had to pay back a portion of the closing consideration. And because the buyer changed the inventory policy right after closing — they started writing down slow movers aggressively — the average dropped. Luna: So the seller not only lost at the peg, but also got hit by a post-closing policy change they had no control over. Lucas: Exactly. And that's the trap. The working capital peg isn't just about comparing two numbers. It's about defining what counts, when you measure it, and who controls the accounting policies after the deal closes. Luna: Let's pause there because this is a perfect example of why a seller needs to understand the mechanics before signing. And honestly, if today's conversation gives you even one practical takeaway for your own deal, I'm glad we did it. Luna: These episodes stay ad-free because of listener support, so if you got something out of this, you can buy us a coffee at buy me a coffee dot com slash fexingo. It's a small way to keep the conversations going. Lucas: Yeah, and we're not shy about it — that support genuinely helps us keep the lights on. But back to Summit. The seller ended up netting thirty-two million less than they thought they were selling for. That's over twenty percent of the deal value. Luna: So what's the lesson for a seller sitting across the table from a buyer's lawyer next week? Lucas: Three things. First, define working capital precisely. List every line item — inventory at lower of cost or net realizable value, accounts receivable net of allowance, prepaid expenses, the works. Don't leave it to 'in accordance with GAAP consistently applied.' Luna: Because 'consistently' can change after closing. Lucas: Right. Second, negotiate the measurement date. Tie it to a trailing average over a full business cycle, not a single point that could land in your slow season. And third, get a cap on the adjustment. Some sellers put a collar — say, plus or minus two million — so the peg doesn't turn into a moving target. Luna: What about the buyer's angle? Is there a legitimate use of the peg? Lucas: Absolutely. The peg exists to make sure the seller doesn't strip out working capital before handing over the keys. That's fair. The problem is when the buyer uses the definition as a weapon to re-trade the price after signing. Luna: In Summit's case, the buyer clearly did their homework. They could see the seasonality, they knew the inventory write-down policy was aggressive — they probably even modeled the exact number they'd end up with. Lucas: No doubt. And that's the second lesson — don't just sign the seller's standard working capital definition thinking it's boilerplate. Treat it as a financial term, not a legal one. Have your CFO or a transaction advisor run sensitivity analyses on different closing dates and different inventory valuation methods. Luna: And that analysis could have saved Summit twenty-two million. Lucas: Easily. Had they pushed back on the definition or the measurement date, they might have walked away with most of that money. Instead, they saw the headline price and missed the forest. Luna: So for our listeners who are thinking about selling — what's the one thing you'd tell them to do tomorrow? Lucas: Pull out your own balance sheet and re-run your working capital under the buyer's likely definition. See what the number looks like at your most inconvenient month. That's the number you should be negotiating from, not the one at your year-end. Luna: That's a great practical takeaway. And if you've got a deal story of your own, we'd love to hear it — you can find us over at the Fexingo network. Lucas: Until next time, keep your eyes on the working capital statement.