The headline price gets the attention. The working capital mechanism, agreed in a paragraph near the back of the agreement, routinely moves more value — and usually in the direction of whoever understood it better.
Most transactions are done on a cash-free, debt-free basis with a normal level of working capital left in the business. That last clause sounds administrative. It decides how much cash actually changes hands, and it is settled in a schedule that gets a fraction of the attention the price does.
The mechanism is simple enough. A target level — the peg — is agreed in advance. At completion, actual working capital is measured. If it is above the peg the buyer pays more; below, the seller receives less. The argument is never about the arithmetic. It is about the peg.
Why a closing balance is the wrong basis
The obvious approach is to take working capital at the most recent month end and call that normal. It is almost never normal. Working capital moves through the year with seasonality, with collection behaviour, and with whatever happened to be paid or unpaid on that particular date.
It also moves in ways a seller can influence without doing anything improper: chasing receivables harder in the run-up, letting payables run, holding less stock. Each is a defensible business decision. Together they can move the closing position well away from the level the business actually needs to trade.
A peg set from one date is a peg set from whichever date happened to flatter one side.
Deriving a normalised level
The defensible approach is to look at the cycle rather than a point on it, and to show the working.
- Take twelve to twenty-four months of monthly positions
One year shows seasonality; two shows whether this year was typical.
- Strip out what is not working capital
Debt-like items, related-party balances, non-trading items and anything already counted in the net debt schedule. Counting something twice is the most common error here.
- Adjust for known distortions
A large one-off order, a customer who paid unusually early, a supplier who changed terms mid-year.
- Look at the underlying drivers
Days of receivable, days of payable, days of stock. A peg that implies a collection period the business has never achieved will not hold.
- Propose the level with the workings attached
The number matters less than whether the other side can follow how it was derived.
Where the disputes come from
- Items sitting in both the peg and the net debt schedule, so the seller is charged twice.
- Accounting policies that change between the peg calculation and the completion accounts.
- Provisions — for bad debts, obsolete stock or disputed invoices — computed one way for the peg and another at completion.
- Accruals and cut-off treated inconsistently either side of the completion date.
- Seasonality argued after the fact by whichever party it favours.
Most of these are avoidable by agreeing the basis of preparation in the same document as the peg: which policies apply, how provisions are computed, what is excluded. That paragraph prevents more argument than any other in the schedule.
Get to it before the letter of intent
Once commercial terms are agreed in principle, the peg becomes a negotiation against a fixed headline price, and every rupee of movement is visibly taken from one side. Before that point it is a technical discussion about how the business actually works, and it is settled far more easily.
That is the practical argument for involving someone early. The analysis is the same either way; what differs is whether it is a conversation about the business or a haggle over the price.