What Is Working Capital?
Working capital is calculated as current assets minus current liabilities. In an M&A context, it represents the level of short-term liquidity embedded in a business and is a central component of deal pricing and closing mechanics.
A normalised working capital peg — agreed between buyer and seller — sets the expected level of working capital to be delivered at closing. Deviations above or below this peg result in purchase price adjustments.
Why Working Capital Matters in M&A
Working capital negotiations are among the most contested elements of any deal. The buyer needs sufficient working capital to continue operating the business post-close without an immediate cash injection. The seller wants to extract cash above normalised levels before closing.
Key working capital issues in transactions include:
- Defining the peg — typically based on a trailing 12-month average, adjusted for seasonality
- Identifying excluded items — cash, debt, and other non-operating items are usually stripped out
- Timing manipulation — sellers may accelerate collections or defer payables around closing
- Quality of earnings overlay — working capital analysis often runs alongside QoE to identify distortions
Working Capital in Deal Structuring
Most M&A purchase agreements include a working capital adjustment mechanism with:
- A target working capital amount (the peg)
- An estimated closing working capital (provided by the seller)
- A post-close true-up period (typically 60–90 days) to reconcile actuals
- A dispute resolution mechanism if the parties disagree on the final number
Working capital disputes are a frequent source of post-close litigation in lower mid-market transactions, particularly where accounting policies differ between buyer and seller.
Related Concepts
- Net debt — often netted against working capital in purchase price calculations
- Quality of earnings — working capital analysis typically runs alongside QoE
- SPA — the sale and purchase agreement governs working capital adjustment mechanics
Related Terms
EBITDA Add-Backs
Adjustments made to reported EBITDA to normalise earnings by removing one-off, non-recurring, or non-operational items — producing an adjusted EBITDA figure used as the basis for deal valuation.
EBITDA Multiple
A valuation ratio that expresses the enterprise value of a business as a multiple of its EBITDA — used in M&A to compare valuations across companies and assess whether a deal is fairly priced.
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortisation — a widely used financial metric in M&A that measures a company's operating profitability before the effects of capital structure, tax policy, and non-cash accounting charges.
Normalised EBITDA
Normalised EBITDA is EBITDA adjusted for non-recurring, owner-specific, or one-off items to reflect the sustainable earnings a business would generate under new ownership. It is the primary metric buyers and M&A advisors use to establish enterprise value and negotiate acquisition price.
SPA (Share Purchase Agreement)
The definitive, legally binding contract in an M&A transaction that sets out all terms and conditions for the sale and purchase of a company's shares, including price, representations, warranties, indemnities, and closing conditions.
SPAC
A Special Purpose Acquisition Company — a publicly listed shell company formed to raise capital through an IPO for the sole purpose of acquiring an existing private company within a specified timeframe.