This transaction mechanism adjusts the final purchase price based on the difference between the actual working capital of the target company at completion and a pre-agreed benchmark, or peg. In corporate acquisitions, the working capital peg adjustment ensures that the target has sufficient operating liquidity to continue its daily operations post completion without requiring immediate cash injections from the buyer. This application is governed by the completion accounts provisions in the share purchase agreement, which set out the methodology for preparing the completion balance sheet.
It stops applying if the parties agree to a locked box mechanism, where the purchase price is fixed at a historical date and no post completion adjustments are made. By implementing this mechanism, the adjustment protects the buyer from the risk of the seller stripping cash or delaying payments to vendors prior to completion, securing a normal level of working capital.
The working capital peg, or target working capital, is calculated during the due diligence phase by analyzing the target company’s historical financial statements, usually covering the preceding twelve months. This calculation represents the average level of current assets, such as trade receivables and inventory, less current liabilities, such as trade payables and accrued expenses, required to support the company’s historical revenue. The parties must agree on the specific accounting policies and definitions that will be used to calculate both the peg and the completion working capital to ensure consistency.
This step is critical because any deviation in the calculation methodology can lead to an artificial surplus or deficit, resulting in an unjustified transfer of value between the parties. The agreed peg is drafted into the purchase agreement alongside a detailed working capital schedule that illustrates the calculation using a sample balance sheet.
Following the completion of the transaction, the buyer’s team prepares a draft completion statement that calculates the actual working capital of the target as of the completion date. This draft is delivered to the seller within a specified period, typically sixty to ninety days post closing, and must comply with the agreed accounting policies. If the actual working capital is higher than the peg, the buyer pays the difference to the seller, increasing the final purchase price.
Conversely, if the actual working capital is lower than the peg, the seller must refund the difference to the buyer, or the funds are drawn from a transaction holdback escrow account. This adjustment ensures that the seller is compensated for any excess value left in the business and the buyer is protected against any deficit in the target’s short term assets, completing the post closing financial reconciliation.
Disagreements regarding the post completion working capital calculations are common and are resolved through a structured dispute resolution procedure set out in the purchase agreement. If the seller objects to the buyer’s draft completion statement, they must deliver a detailed dispute notice within a specified period, typically thirty business days. The parties must then attempt to resolve the disputed items in good faith through senior negotiations for a set period, such as twenty business days.
If they fail to reach an agreement, the disputed items are referred to an independent accounting firm, which acts as an expert to make a final and binding determination. The expert’s costs are usually allocated between the parties based on the extent to which each party’s position is upheld. This structured settlement process prevents the parties from engaging in prolonged and expensive litigation, ensuring a definitive resolution to valuation disputes.
Quantifying true target EBITDA under integrated parent allocations requires stripping internal cost-plus entries and substituting validated third-party vendor quotes.
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