Working Capital Adjustments: What They Are and Why They Catch Sellers Out

Most business owners focus their attention on the headline price. Fewer pay enough attention to the working capital adjustment, and that is often where value quietly disappears between agreeing Heads of Terms and receiving the final payment.

What is working capital?

Working capital is the cash tied up in the day-to-day running of the business. Broadly, it is stock plus trade debtors, less trade creditors and other short-term liabilities. It is the fuel that keeps operations moving between paying suppliers and getting paid by customers.

Every business needs a certain level of working capital just to function normally. A buyer is not paying to acquire a business that runs out of cash the week after completion, so the deal must account for how much working capital comes with it.

Why it matters in a sale

Most transactions are agreed on a cash-free, debt-free basis, with a "normal" level of working capital included in the price. That normal level is called the target, or the peg.

At completion, the actual working capital in the business is measured and compared to that target. If completion working capital is higher than the target, the seller typically receives an additional payment. If it is lower, the price is reduced pound for pound. This is why the mechanism deserves as much attention as the headline Enterprise Value. A well negotiated valuation can be eroded significantly by a poorly negotiated working capital target.

How the target is set

The target is usually based on an average of historical working capital over a defined period, often 12 months, to smooth out seasonal swings. Getting this period right matters. A business with seasonal stock builds or a lumpy debtor book can end up with a target that does not reflect how the business actually operates, and that mismatch works against the seller.

This is a negotiation point, not a formality. Buyers will often propose a period or a methodology that suits them. Sellers should expect their adviser and accountant to test whether the proposed target genuinely reflects normal trading, rather than accepting the buyer's first draft.

Completion accounts and the true-up

Once the deal completes, the actual working capital position is calculated from a set of completion accounts, prepared shortly after the deal closes. This is compared against the agreed target, and a "true-up" payment is made in whichever direction the numbers point.

This process can take weeks or months to finalise, and it is a common source of post-completion dispute. Definitions matter enormously here. What counts as a trade debtor. Whether accrued income is included. How work in progress is valued. Ambiguity in the Share Purchase Agreement at the drafting stage becomes a live argument once real numbers are on the table.

Where sellers get caught out

A few patterns come up repeatedly on deals:

Stripping cash before completion. Owners sometimes draw down cash reserves before a sale, not realising this can pull working capital below the target and trigger a deduction from the price they expected.

Ignoring the definitions schedule. The SPA will contain a detailed definition of what is and is not included in working capital. This is not boilerplate. It is where the real financial exposure sits, and it deserves the same scrutiny as the price clause itself.

Underestimating timing risk. Because the true-up happens after completion, sellers can find themselves negotiating from a weaker position once they no longer control the business or have full visibility of how the buyer is preparing the completion accounts.

Treating it as an afterthought. Working capital mechanics are technical and can feel less important than agreeing the price. In practice, a badly structured mechanism can move the effective consideration by a meaningful percentage either way.

The practical takeaway

Working capital adjustments are not a technicality to be left to the lawyers at the last minute. They should be scoped early, ideally before Heads of Terms are signed, so that the target, the reference period and the definitions are all understood and agreed in principle before they are drafted into legal documents.

Getting this right protects the value that has already been negotiated on price. Getting it wrong can undo weeks of careful negotiation in a single completion accounts dispute.