Definition
A working capital peg is the agreed level of working capital a business must contain when the sale completes. If actual working capital at completion is above the peg, the buyer usually pays the difference; if it is below, the price comes down. The peg is often set from the average of month-end balances over the previous year, so that it reflects a normal level. In the UK it is often called a target working capital figure.
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.
Worked example
Copperleaf Supplies Inc. is a fictional US distributor sold for $4,000,000 on a cash-free, debt-free basis. Buyer and seller agree a peg of $600,000, the average of the last 12 month-end balances.
- At closing, working capital is measured at $520,000.
- The shortfall is $80,000, so the price falls to $3,920,000.
Had working capital come in at $650,000, the buyer would usually have paid $50,000 more.
Cash-free, debt-free is a pricing basis in which the headline price assumes the business changes hands with no cash and no borrowings. The seller keeps the cash, repays the debt and leaves a normal level of working capital behind.
Why buyers care
Without a peg, a seller can collect debts early, run down stock and delay paying suppliers before completion, taking cash out and leaving you to refill the business. A peg protects the value you agreed to pay for.
The detail matters. Define which balance sheet lines count, which accounting policies apply and who prepares the completion figures, and by when. Check whether the business is seasonal, since an annual average may not suit a completion date at a peak or a trough. Because these definitions are both legal and technical, ask your accountant and lawyer to review them before you sign.