Is This Working Capital Peg Fair? A Seven-Question Framework

The Letter of Intent (LOI) arrived on Monday. Headline price looks right. Then, buried in Schedule 2, there is a working capital target: one line, a dollar figure, a cross-reference to a definitions section you have not opened yet. Your attorney glances at it and says, "That is standard, do not worry about it." You have seventy-two hours to sign.

The peg is where owners most often lose money they thought they had already won. The headline price is a negotiation. The peg is a formula. If the formula is wrong, the formula wins, and the dollars come straight out of your proceeds at close. Below is the seven-question check to run before you sign. If you want the full mechanics behind the framework, start with the pillar: The Working Capital Peg: What Owners Lose at the Closing Table.

The seven-question risk assessment

For each question, read the three descriptions and classify the peg as drafted: Green (acceptable), Yellow (adequate but worth pressing), or Red (negotiate before signing). The point is not to average the colors. One Red answer can cost more than the other six combined, and that is reflected in how you read the result at the bottom.

1. Base period selection

Is the peg built on a representative stretch of the business, or a window picked to favor the buyer?

• Green: Full twelve-month Trailing Twelve Months (TTM) average, or longer window covering at least one complete business cycle, methodology spelled out in the LOI.
• Yellow: Twelve-month average, but the window ends in a month not representative of your run rate.
• Red: Three-month or six-month window that lands on your lowest Net Working Capital (NWC) quarter.

2. Exclusions for non-recurring items

Does the peg carve out one-time events, or does it quietly pull them into the baseline?

• Green: Non-recurring items (one-time inventory builds, prepaid deposits tied to a specific customer, pandemic-era anomalies) are explicitly listed as exclusions in the LOI or a referenced schedule.
• Yellow: General "normalization" language with no specific items named.
• Red: No exclusions. The twelve-month average is the twelve-month average, period, even if six of those months contain a one-time inventory position.

3. True-up window

How long after close does the buyer have to compute final NWC and send the bill (or check)?

• Green: Sixty to ninety days post-close, with a hard deadline and a defined process if the buyer misses it.
• Yellow: Roughly one hundred twenty days.
• Red: One hundred eighty days or longer, with no penalty for a buyer who drags out the calculation. The longer this window, the more time the buyer has to find reasons the delivered number was lower than acknowledged.

4. Dispute mechanism

If you review the buyer's post-close NWC calculation and disagree, what happens?

• Green: A mutually selected independent accounting firm arbitrates, with a defined cost split and tight timeline.
• Yellow: A named firm, but the buyer picks from a shortlist and the cost split is less defined.
• Red: Buyer-selected arbiter with no cap on cost, or litigation only. If the only path to challenge the number is a lawsuit, you will not challenge the number.

5. Seasonality adjustment

If the business has a real seasonal cycle, does the peg reflect it?

• Green: Seasonality is explicitly addressed. The peg is either a monthly target curve or an average adjusted for the specific month of close.
• Yellow: Flat twelve-month average on a mildly seasonal business.
• Red: Flat twelve-month average on a sharply seasonal business, with the close date at the buyer's discretion. You are rooting for a specific closing month with no control over which one you get.

6. Treatment of customer deposits and deferred revenue

Are customer prepayments part of normalized working capital, or debt-like items that reduce purchase price dollar-for-dollar?

• Green: Customer deposits and deferred revenue are explicitly excluded from the debt-like definition and either carved into their own schedule or treated as a normal current liability inside the peg.
• Yellow: Ambiguous. The definitions section can be read either way.
• Red: Prepaid deposits classified as indebtedness with no carve-out. Every dollar of customer money sitting on your balance sheet at close becomes a dollar-for-dollar reduction in proceeds.

7. How the peg appears in the LOI

Specific number with methodology, or deferred?

• Green: A specific target number, with the calculation methodology attached as a schedule, with the base period, the components, and the exclusions all written out.
• Yellow: A target range (for example, "between $4.5 million and $5.0 million") with the final number set by defined methodology.
• Red: "To be determined at close based on buyer's review of trailing financials." A peg left open at the LOI stage is a peg the buyer intends to set after the announcement is public and you are too far down the path to walk.

How to read your result

Count your Green, Yellow, and Red answers across the seven questions, then apply the lowest-color override: any Red overrides the composite.

• Any Red answer: high risk. One Red can cost more than the other six questions combined. Negotiate that specific dimension before the LOI is signed, regardless of how the other six look. If the buyer will not budge on a Red answer, that itself is a signal about the broader deal.
• No Reds, five or more Green: workable. The peg is well-structured. Press on any Yellow dimensions in the definitive agreement, but you do not need to hold up the LOI.
• No Reds, three or four Green with the rest Yellow: moderate risk. Target the Yellow dimensions and press for Green language on at least two before the definitive agreement is drafted. Most deals land here.
• No Reds, two or fewer Green: elevated risk. The peg is drafted to extract value through ambiguity. Push for Green language on at least three dimensions before signing.

A short worked example

The numbers below are an illustrative composite, not an actual client.

An owner receives an LOI for her specialty distribution business. Headline price is $22 million cash at close, with a working capital target of $4.6 million based on a six-month trailing average ending in September. The business is seasonal, with inventory peaking in October and November. She classifies the seven questions:

• Base period: Red (six-month window landing on the trough quarter)
• Exclusions: Yellow (general normalization language, no specific carve-outs)
• True-up window: Yellow (one hundred twenty days)
• Dispute mechanism: Green (named independent accounting firm, shared cost)
• Seasonality adjustment: Red (flat average on a sharply seasonal business)
• Deposits treatment: Green (deposits explicitly excluded)
• Peg appearance in LOI: Green (specific number with methodology schedule)

Two Reds. High risk, regardless of the three Greens.

She counters on the two Red dimensions. She asks for a full twelve-month trailing average instead of six months, and for an explicit seasonality adjustment that targets the actual month of close. She also pushes on exclusions, asking for one-time inventory builds to be carved out. The buyer agrees to twelve months and to the inventory carve-out, but holds firm that seasonality will be addressed through the base period choice rather than a separate adjustment.

Her revised classifications: base period moves to Green, exclusions moves to Green, and seasonality moves to Yellow (the full-year window captures the Q4 peak as well as the trough, which partially offsets the lack of an explicit adjustment). Five Greens, two Yellows, zero Reds. Workable. She signs.

She did not get everything. She identified the dimensions where the peg was most exposed, pressed on each, and converted a high-risk peg into a workable one before the LOI was signed. Those conversations were worth low six figures at close.

When to walk away from the peg conversation

Three situations tell you something important about the broader deal.

A buyer who refuses to budge on exclusions is signaling intent to use non-recurring items against you. A buyer who will not clarify what counts as recurring at the LOI stage will not clarify it in the definitive agreement either.

A buyer who refuses to shorten the true-up window below one hundred eighty days wants the time for a reason: to find reasons the delivered number was lower than acknowledged.

A buyer who refuses any neutral dispute mechanism is telling you they do not want their math reviewed. If the only path to challenge the calculation is a buyer-selected arbiter or litigation, you have no practical path.

Any one of these is a signal to slow down. All three together are a signal that the peg is not the only mechanic in this deal that will be used against you.

A note on the risk tiers

The "any Red overrides the composite" rule is an editorial judgment, not a published standard. A Red on dispute mechanism or true-up window is not identical in impact to a Red on peg appearance in the LOI. The point of the override is that any one of these can swallow the other six, not that each one weighs the same. Use the risk tier as a starting point for the conversation with your advisors, not a verdict.

If you want to pressure-test the peg number itself, not just the structure, try the working capital peg calculator. Model your own trailing-twelve-months of NWC against five different peg methods and see how much the method choice is worth before the buyer picks one for you.