Meaning
A target amount of liquid assets a company must have on its balance sheet at the time a sale is completed. The working capital peg ensures the business has enough cash and inventory to continue operating without immediate further investment from the buyer. If the actual amount falls below this level, the purchase price is adjusted downward.
It is a static reference point for the final financial health of the entity.
Target Adjustment
Comparing the actual assets to the agreed target happens on the closing date. If the working capital peg is higher than the actual current assets minus current liabilities, the seller pays the difference. This adjustment prevents the founder from stripping cash out of the business right before the sale.
Balance Sheet Accuracy
Accuracy in the accounts is paramount for a smooth transaction. The working capital peg is calculated using a trailing average of the business needs over the previous year. This prevents seasonal spikes from unfairly penalizing either party.
Cash Requirement
Every firm needs a certain amount of liquidity to pay its bills. The working capital peg protects the buyer from discovering an empty bank account on day one. Meeting this target requires the founder to manage accounts receivable and inventory carefully in the months leading up to the exit.
