A $20 Million Distribution Sale and a $500,000 Working Capital Shortfall: A Worked Example

The working capital peg is the mechanic that most often turns a confident owner into a confused one on the morning of close. Below is a composite example that stitches together patterns we see repeatedly in lower middle market distribution deals. The company, the figures, and the outcome are illustrative, not a real client case.

Setting the scene

Picture Horizon Industrial Supply, a regional distributor of maintenance, repair, and operations products. Revenue is roughly $42 million. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is around $3.1 million. The owner, call her the founder, is 58 and ready to sell. A strategic buyer signs a Letter of Intent (LOI) in July at a $20 million headline enterprise value. Target close: November 15, the Friday before Thanksgiving.

Inside the purchase agreement sits a single sentence that will cost her $500,000 before anyone pours coffee on closing morning: "Net Working Capital (NWC) target shall equal the Trailing Twelve Months (TTM) monthly average, computed as $4,800,000. Delivered NWC below the target shall reduce the purchase price dollar for dollar."

She reads that line in August the way most owners read it: as a technicality her Chief Financial Officer (CFO) will handle. She does not model it against her own monthly balance sheet.

What NWC looked like over the trailing twelve months

Horizon is seasonal in a specific way. Industrial customers pre-buy maintenance inventory in Q4 ahead of January production starts. Accounts Receivable (AR) and inventory both swell from September through December, then unwind through Q1. Q2 is the trough. Here is the TTM pattern, in monthly NWC balances (AR plus inventory plus prepaid expenses minus Accounts Payable (AP) minus accrued liabilities, cash and debt excluded):

The average is clean. The pattern underneath it is not. The business is above $5.0M for five months and below $4.5M for four. The spread between April ($4.2M) and December ($5.6M) is $1.4M, or 29% of the average. That is a pattern worth flagging at the LOI stage. No one flagged it.

What NWC looks like on close day

The founder ran the business normally. She did not hoard inventory or push her sales team to pull AR current. On November 15, delivered NWC lands at $4.3M.

Why so far below the $4.8M target on a day that sits right before the Q4 peak? Timing. November 15 is the hinge. Most Q4 pre-buy orders have been placed and received into inventory, but AR has not caught up because those invoices carry net 30 or net 45 terms. The AR balance on November 15 reflects October shipments, not the Q4 surge. Inventory is up, but AP is also up, because Horizon has not yet paid its own suppliers for the pre-buy stock. The net position sits in the trough of a seasonal pattern that nobody translated into the peg.

The math at close

The peg mechanic is simple arithmetic once the numbers land. Target is $4.8M. Delivered is $4.3M. Shortfall is $500,000. The purchase agreement reduces the headline dollar for dollar.

Headline enterprise value:          $20,000,000
NWC target (TTM average):            $4,800,000
NWC delivered at close:              $4,300,000
NWC shortfall:                         $500,000
Purchase price adjustment:            -$500,000
Actual proceeds at close:           $19,500,000

The founder signed an LOI at $20M and received $19.5M. The $500,000 did not disappear into fees or taxes. It stayed with the buyer, as a dollar-for-dollar reduction, because the delivered NWC on a specific calendar date did not match an average computed across twelve months. There is nothing clever about the mechanic, and nothing accidental about which side of the trade benefits when the peg is a flat TTM average and the close date sits in the trough.

What the owner should have done

Four levers were available between July and November that would have changed this outcome. Any one would have recovered part of the $500,000. Together, they would have eliminated it.

One. Model every methodology before you negotiate one. The common owner instinct is to assume a shorter trailing window is fairer than a TTM average. On this business, that instinct would have made things worse. The three months before close were August, September, and October, which averaged $5.1M because they sit on the leading edge of the Q4 inventory ramp. A three month trailing peg would have landed at $5.1M, increasing the shortfall from $500,000 to $800,000. The methodology that sounds fairer is not automatically fairer. The right methodology for a seasonal business is one that is modeled against delivered NWC on the specific close date, usually a seasonality adjusted base period or an explicit average of comparable prior year months. Negotiate the methodology in the LOI, after modeling at least three options on your own balance sheet, not in the purchase agreement two weeks before close.

Two. Push the close date into the up cycle. November 15 was the buyer's preferred date. Closing in late December or January would have landed delivered NWC in the $5.2M to $5.6M band, above the TTM peg rather than below it. Close dates feel fixed. They are not. They are negotiated like every other LOI term, and balance sheet seasonality is a legitimate input.

Three. Carve out the seasonal AR cycle as an excluded item. Purchase agreements routinely exclude specific balance sheet categories from the peg: cash, debt, debt like items such as customer deposits. Nothing prevents the parties from excluding or adjusting for a defined seasonal AR pattern if the mechanic is written clearly. This is a drafting conversation attorneys and CFOs can raise in redlines, if the owner knows to ask.

Four. Right size the AR aging in the ninety days before close. This is the operational lever. A targeted collections push on current receivables, inside normal credit terms, can pull AR forward and lift delivered NWC by several hundred thousand dollars without changing the shape of the business. It is paying attention to a balance sheet item the buyer is about to measure.

Three lessons the owner should take

One. The average hides the pattern, and the pattern decides which methodology actually helps. A flat TTM average is a single number. The business behind it is not flat. If you have seasonality in AR, inventory, or AP, the peg methodology matters more than the peg level, and the methodology that reads fairer on paper can be worse once you run it against your actual balance sheet. Model every realistic methodology on your own data before you accept, counter, or propose one.

Two. The close date is a peg lever. Most owners negotiate price. Fewer negotiate structure. Almost none negotiate the calendar. On a seasonal business, the close date is worth real money and should be modeled, not accepted.

Three. The time to argue the peg is before you sign the LOI. Once the deal has momentum, peg terms harden. The owner who understands her NWC pattern in July can shape the peg. The owner who first reads the peg clause in October accepts whatever the buyer proposes.

Why pre sale readiness work makes this easier

The Horizon story is a readiness problem before it is a negotiation problem. An owner who has spent the twenty four months before an LOI understanding her monthly NWC pattern, cleaning up AR aging, and watching her current ratio does not get surprised by a peg. She walks into the LOI with her own number. She knows the TTM average, the three month trailing average, and the point in time balance she will deliver in any given month, and she can counter the buyer's proposed methodology with data. This is exit planning in its most concrete form. Enterprise value gets most of the attention because it is the biggest number on the page. Working capital adjustments quietly move hundreds of thousands of dollars, sometimes millions, between owner and buyer at close. The owner who prepares captures that money. The owner who does not prepare contributes it.

A note on these numbers

The figures above are a composite constructed to illustrate how a seasonal NWC pattern interacts with a flat TTM peg. They are not drawn from any client engagement. Every actual working capital adjustment has its own definition of NWC, its own base period, its own excluded items, and its own interaction with holdbacks. Treat this piece as a mental model, not a forecast.