The Working Capital Peg: The Hidden Number in Your Sale

Published October 2, 2026  ·  Last updated: September 2026  ·  Tax Preparation & Planning

The Working Capital Peg: Where Money Moves on Your Closing Statement

By Nick Termine, CPA and Stephen Calvo, CPA, Partners, TC Advisors CPA | Licensed NY & NJ

What Is the Peg, and Why Do Buyers Insist on One?

A buyer paying enterprise value for a business expects to receive it with enough working capital to operate normally from day one: enough receivables to collect, enough inventory to sell, enough cash conversion to make payroll without immediately injecting money. The peg fixes that level in the agreement so the seller cannot strip the business before handing it over. Without a peg, the incentive is obvious, a seller could collect every receivable aggressively, run inventory to nothing, stretch payables to sixty days, and sweep the cash, handing over a business that looks identical on the profit and loss and is starved on the balance sheet.

The peg exists to stop that. It is a legitimate protection, and buyers in this market rarely do a deal without one. The negotiation is not whether to have a peg. It is how it is calculated, what goes into the definition, over what period, and who bears the cost of a swing that neither side controls. That is four separate negotiations, and sellers usually treat it as one number.

How Does the Number Get Built?

The peg is almost always derived from the target's own history. The buyer's advisers pull twelve to twenty-four months of monthly balance sheets, calculate working capital at each month end, and take an average. Three choices inside that process determine the outcome:

• The period. Twelve months or twenty-four. For a business that grew over the period, a longer window produces a lower average, and a lower peg favors the seller. For a business that shrank, the reverse.
• The month ends included. A business with a genuine seasonal cycle can produce very different averages depending on which months are in the sample. This is where the largest distortions live.
• The adjustments. Non-recurring items, related-party balances, uncollectible receivables, obsolete inventory, and disputed payables all get normalized. Every adjustment moves the peg.

None of this is improper. All of it is discretionary, and the party doing the calculation is the buyer, which is exactly why you want your own number before theirs arrives.

Why Is the Definition Worth More Than the Peg?

Here is the point most sellers miss entirely, and it is worth more than the negotiation over the peg itself. Working capital in a purchase agreement is a defined term, not an accounting standard. It means whatever the agreement says it means, so two deals with identical pegs can produce completely different outcomes because one includes an item the other excludes.

Table: how each line item is typically treated in a working capital definition, and where the money moves. TC Advisors CPA, September 2026.

Deferred revenue is the line to watch in any business with prepayments, retainers, subscriptions, or deposits. If customers have paid in advance for work not yet delivered, that liability sits on the balance sheet, and whether it counts against your working capital delivery can move the settlement substantially. There is no universal answer; it is negotiated. Settle the definition before you settle the number, because agreeing a peg against an undefined term is agreeing to something you cannot calculate.

Why Is Seasonality the Trap?

Average-based pegs and seasonal businesses interact badly, and nobody notices until the closing date is set. Consider a business whose working capital runs at $1,400,000 in its busy months and $600,000 in its quiet months. The twelve-month average might be $1,000,000, and that becomes the peg.

Now close in the busy season. You are required to deliver $1,000,000, and the business naturally holds $1,400,000 at that moment, so you have handed over $400,000 more than the peg. If the agreement pays you the excess, fine. If it has a collar or a one-way adjustment that only penalizes shortfalls, you have just given away $400,000. Close in the quiet season and the position reverses, which is why buyers pay attention to closing dates too. The fix is not complicated: use a seasonally adjusted peg that varies by month, or make the adjustment mechanism symmetrical so excess is paid to the seller. Both are normal. Neither happens unless somebody asks.

What Should You Negotiate, in Order of Value?

Sellers who engage with this early tend to pursue five things, and they are not equally important:

• A symmetrical adjustment, so working capital delivered above the peg is paid to you rather than absorbed.
• A tight definition, with deferred revenue, accrued PTO, and related-party balances addressed explicitly rather than left to interpretation.
• Agreed accounting policies, stating the closing statement is prepared using the same methods and reserve levels used in the historical statements the peg was derived from. This single clause prevents the most common dispute, where the buyer applies more conservative reserves to the closing balance sheet than were ever applied historically.
• A dispute mechanism with a named independent accountant and a defined timetable, so a disagreement resolves rather than lingers.
• A cap or collar, so small movements inside a band do not trigger an adjustment at all.

The third item is the one advisers fight hardest for and sellers understand least. Consistency of method is the difference between a calculation and a renegotiation. The sellers who do well on the peg are the ones who arrive with evidence rather than confidence: a two-year payment history beats an assurance that a receivable is good, and a movement report beats a claim that inventory is not obsolete. That is a preparation problem, solvable months before a buyer exists.

How Does the Peg Meet the Quality of Earnings Analysis?

The peg is not a standalone exercise. It is one output of the same diligence work that produces the earnings analysis, and the two interact. A quality of earnings analysis rebuilds your reported profit into the number a buyer will pay a multiple on: it tests whether earnings convert to cash, strips out items that will not recur, and normalizes owner compensation and personal expenses.

That work surfaces exactly the items that also drive the peg. Revenue recognized early inflates both earnings and receivables. Expenses recorded late flatter earnings and understate payables. A change in payment terms improves cash flow temporarily and distorts the working capital average for the months it covers. So a buyer who finds a cutoff problem in the earnings analysis will usually apply the same finding to the peg, one issue, two price effects, and sellers frequently only anticipate the first. Preparing both together is the efficient path, which is why sell-side preparation treats them as one engagement. This is part of the broader financial and tax due diligence that both sides run before a deal closes.

Does the True-Up Have a Tax Tail?

Sellers treat the working capital settlement as a cash event and stop thinking about it once it clears. It is also a change to the purchase price, and the purchase price is the number both sides allocate across the assets for tax purposes. The IRS is explicit that in an asset sale, both the buyer and seller must use the residual method to allocate the price to each asset transferred, reported on Form 8594 by both parties. A settlement that moves the price after closing moves the number the allocation starts from.

In practice this produces a specific, avoidable mess. The agreement is signed with one price; the working capital true-up lands sixty to ninety days later and adjusts it; then two sets of accountants prepare two returns, and unless someone coordinates them, the buyer and seller file allocations built on different totals, an inconsistency visible to the IRS because both forms are filed. And where the adjustment is finalized after the original Form 8594 has already been filed, the IRS instructions call for a supplemental Form 8594 in the year the increase or decrease in consideration is taken into account, a filing missed far more often than made. The fix is procedural and costs nothing if done on time: agree in the purchase agreement that the allocation will be finalized after the working capital settlement is determined, name who prepares it, and require both parties to file consistently. Ask for that clause during negotiation. Nobody objects to it, and almost nobody raises it. The mechanics connect to our guide on the basis step-up and purchase price allocation.

Frequently Asked Questions

What is a working capital peg in simple terms?+

Who calculates the peg?+

Why does the definition of working capital matter more than the peg?+

How long after closing does the true-up happen?+

We are a seasonal business. What should we push for?+

Can I object to the buyer's final calculation?+

Does the true-up have a tax effect?+

Nick Termine, CPA and Stephen Calvo, CPA are the co-founding partners of TC Advisors CPA, a boutique tax and advisory firm in Hackensack, New Jersey. Both began their careers in Big Four public accounting and advise closely held businesses and their owners through sales, acquisitions, and transaction structuring across Northern NJ and the NYC metro. TC Advisors is licensed in New York and New Jersey.

Related: Financial & Tax Due Diligence, Rollover Equity and the Second Bite, and The Basis Step-Up and Purchase Price Allocation.