Working Capital Adjustments at Closing

Conor Meyers — Co-Founder & Business AttorneyHas built and run businesses; advises owners on contracts, transactions, and risk. About Conor →

The price you shook hands on is rarely the price that clears. Working capital is why.

A business sold on a debt-free, cash-free basis is assumed to come with enough working capital to keep running. The parties set a target, measure the actual figure at closing, and adjust the price by the difference. Setting the working capital peg is where the negotiation lives, because the peg decides who benefits from ordinary fluctuation.

We handle these matters for growth-stage companies in Idaho and California. This is general information — not legal or tax advice on a specific situation.

A peg without an accounting policy is an invitation to litigate.

What working capital means in a deal

Net working capital definition deal language typically means current assets less current liabilities, excluding cash and debt where the transaction is on a debt-free, cash-free basis. Receivables, inventory, and prepaid expenses go in; payables and accruals come out.

The definition should be written into the agreement with a worked example, not left to general accounting principles. Two accountants applying the same standards to the same balance sheet can reach different figures on inventory reserves and receivable allowances.

Attach the worked example. It settles more than the definition does.

Setting the peg

The target is usually a trailing average — often twelve months — intended to represent a normal level for the business. Seasonal businesses need care, because a peg struck at a seasonal peak or trough transfers value to one side by accident.

Buyers argue for a higher peg, sellers for a lower one, and both should recognize that the peg moves the effective price dollar for dollar. It belongs in the letter of intent alongside price rather than being discovered during drafting.

The peg moves the price dollar for dollar. Negotiate it like price.

Excluded items and the accounting policy

Excluded items working capital disputes are avoidable with a list. Common exclusions are cash, indebtedness, transaction expenses, deferred revenue, income tax accounts, and anything already addressed by a specific indemnity.

The agreement should also state that the closing statement is prepared using the same accounting practices, applied consistently, as those used to calculate the peg. Without that, a buyer can restate reserves at closing and manufacture a shortfall.

Same policy, consistently applied. That one clause prevents most disputes.

The true-up and dispute mechanics

The post-closing true-up process runs on a timetable: the buyer prepares a closing statement within a set period, the seller has a window to object with specifics, and the parties negotiate before escalating.

Disputes over closing balance sheet items should go to an independent accountant acting as expert rather than arbitrator, deciding only the items still in dispute and only within the range the parties have claimed. A holdback funded at closing gives the mechanism teeth.

Expert determination, limited to the disputed items, within the claimed range.

What this means in practice

Sellers should also negotiate access rights during the objection window. The buyer controls the business and the books after closing, so a seller asked to object to a closing statement within thirty days needs the underlying workpapers to do so meaningfully. Without an express right to them, the objection period can pass while the seller is still requesting documents.

Most of these problems are cheaper to prevent than to argue about.

The underlying rules on this are published directly by Internal Revenue Service, U.S. Small Business Administration, Idaho Legislature, and both are worth reading before you rely on a summary of them — including this one.

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