According to the Stanford GSB 2024 Search Fund Study, the median search fund deal closes at roughly 7x EBITDA with a combination of equity, senior debt, and seller financing. What that number doesn't show is how often working capital disputes erode the purchase price, or kill the deal entirely, in the final weeks before close.
The working capital peg is the single most negotiated term between the LOI and the closing table in lower-middle-market acquisitions. Most sellers don't know it exists until their attorney explains it. Most buyers underestimate how much negotiating power it creates. Understanding it completely changes how you structure an offer.
What the Working Capital Peg Actually Is
Working capital is current assets minus current liabilities. In a business acquisition, the convention is that the seller delivers the business with enough working capital to operate it at its historical level. That amount is the "peg."
If the business delivers working capital above the peg at close, the buyer pays more. If it delivers below the peg, the purchase price decreases dollar for dollar.
Simple in theory. In practice, every word in the preceding paragraph is negotiable.
What counts as current assets? Does cash get included? What about accounts receivable older than 90 days? Does inventory get valued at cost or at market? What's the lookback period used to calculate the peg: the trailing twelve months, the prior three fiscal years, or a rolling average? Who does the calculation, and what accounting standards govern it?
These aren't technical footnotes. They're where significant money moves.
Why the Peg Matters More Than the EBITDA Multiple
In a typical search fund deal at $5M purchase price, a working capital shortfall of $400,000 at close reduces the effective purchase price by 8%. That's a bigger impact than half a turn of EBITDA at common valuation multiples.
The mechanism works in both directions. Buyers want to receive a fully funded business — one they can run from Day 1 without injecting additional operating capital. Sellers want to maximize proceeds, which means minimizing what they leave behind at close.
The conflict is structural. Sellers know their business. They know which receivables will collect and which won't. They know whether that inventory turns or sits. A buyer who hasn't owned this specific business yet doesn't have that knowledge. That information asymmetry creates negotiating power that shifts throughout the diligence process.
How the Peg Gets Set
Most deals calculate the peg as the average working capital over the trailing twelve months, sometimes excluding certain months that reflect seasonal highs or lows. The logic is that a normalized figure represents what the business actually needs to operate.
This is where the fight starts.
Sellers want to calculate the peg during periods when working capital was historically low: right after a strong collections quarter, at the end of a favorable inventory cycle, or during a period when accounts payable happened to run high. Buyers want to peg to periods when working capital was high and business conditions were representative.
The lookback period choice alone can shift the peg by hundreds of thousands of dollars on a mid-size deal. Neither side is wrong. Both are optimizing for their own economic interests.
The resolution is almost always a negotiated compromise: an agreed methodology written into the purchase agreement, with a post-closing true-up mechanism that adjusts the purchase price once the books are finalized 60 to 90 days after closing.
Post-Closing True-Up: Where Disputes Actually Surface
The true-up is where working capital disputes become expensive. Here's the typical sequence:
The parties agree to a target working capital peg of, say, $800,000. The purchase price is set assuming the business delivers exactly $800,000 at close. After closing, the buyer's accountants calculate actual working capital on the closing date balance sheet. If actual working capital is $720,000, the seller owes the buyer $80,000. If it's $870,000, the buyer owes the seller $70,000.
In practice, the buyer does the initial calculation and presents it to the seller. The seller reviews and disputes items they believe were calculated incorrectly. If they can't reach agreement, they go to an independent arbitrating accountant. A process that costs both parties money and time and rarely produces a complete win for either side.
The disputes that survive to arbitration typically involve:
- Accounts receivable aging cutoffs (what qualifies as collectible)
- Inventory valuation methodology (cost vs. net realizable value)
- Accrued liabilities the seller claims were excluded from the calculation
- One-time items the buyer wants to normalize out of the closing balance sheet
These disputes are predictable. A quality of earnings report and a clearly drafted working capital definition in the purchase agreement prevent most of them.
Cash-Free, Debt-Free Closing Convention
Most search fund acquisitions close on a "cash-free, debt-free" basis. This convention interacts directly with the working capital peg in ways that first-time buyers regularly misunderstand.
Cash-free means the seller takes all cash out of the business at close. The purchase price assumes zero cash on the balance sheet on closing day. The buyer receives the operating assets and liabilities, but not the cash account.
This creates an obvious question: if cash is excluded from the closing balance sheet, does it also get excluded from the working capital calculation? The answer depends entirely on how the purchase agreement defines working capital. Most deals exclude cash from both the numerator and the peg calculation, which is internally consistent. Some deals include cash in working capital but then add a line item for excess cash as a purchase price adjustment.
Either approach works if it's defined clearly. The deals that generate disputes are the ones where this interaction wasn't made explicit in the LOI and the purchase agreement was drafted by counsel working from different assumptions.
Debt-free means the seller repays all interest-bearing debt at close. The acquisition debt the buyer takes on is new, used to fund the purchase price. The seller's existing credit lines, term loans, and equipment financing come out at close. This part is usually less contentious than the working capital calculation because debt balances are easy to verify from lender statements.
Seasonal Businesses Require Additional Care
The standard trailing-twelve-month average breaks down for businesses with significant seasonality. An HVAC company carries peak inventory and receivables heading into summer. A tax preparation firm has minimal working capital in August and maximum working capital in April. A landscaping business looks entirely different in March than in November.
For these businesses, the working capital peg needs to account for where the business is in its seasonal cycle on the expected closing date. A buyer closing a landscaping acquisition in October should not be penalized because the business is naturally at a seasonal low. A seller closing in March shouldn't be required to leave behind peak-season working capital that they'll never be able to extract at that level again.
The solution is a seasonally adjusted peg: a calculation that normalizes working capital to the expected level at the specific closing date rather than using a flat annual average. This requires the buyer and seller to agree on a seasonal curve, which requires good historical data and a willingness to work through it.
Buyers who skip this work on seasonal businesses create expensive problems for themselves. The true-up dispute on a poorly defined seasonal peg can absorb more time and legal cost than the original diligence.
What Good Looks Like in Practice
Well-structured search fund deals address working capital explicitly at the LOI stage. Not every calculation detail, but the framework: what's included, what's excluded, what lookback period, and what true-up mechanism.
An LOI that says "working capital to be determined at close based on historical norms" is setting up a dispute. An LOI that says "working capital peg calculated as trailing twelve-month average of net working capital, excluding cash and excluding current portion of long-term debt, with a 90-day post-closing true-up and a $25,000 dispute threshold before arbitration" gives both parties a framework they can build on.
The specificity isn't bureaucratic. It's risk management. It forces both sides to confront the calculation before they're under closing pressure. It surfaces disagreements when they're still solvable rather than when the buyer's lender has already committed and the seller has already signed the lease termination on their office.
The due diligence process should include a working capital analysis alongside the quality of earnings review. Understanding how working capital has moved over the trailing 24 months, and why, is as important as understanding EBITDA normalization. Both tell you whether the business you're buying is the business you think you're buying.
The Operator's Read
EOD protocol: identify the device before you approach it. The working capital peg is predictable in structure. Every deal has one. The disputes are predictable in type. Most of the damage happens because one or both parties didn't engage with the mechanism until they were under closing pressure.
The correct response is not to treat the peg as a detail to be resolved by counsel at the eleventh hour. It's to treat it as a core economic term that belongs in the LOI, gets refined in diligence, and gets drafted precisely in the purchase agreement. That sequence doesn't add time to a deal. It removes the three-week true-up dispute that otherwise shows up 90 days post-closing.
The deals that close cleanly on working capital are the ones where the buyer understood what they were agreeing to before the letters of intent were signed.
Jonathan Bates is a former U.S. Navy Explosive Ordnance Disposal officer. He applies systematic threat identification to acquisition due diligence and deal structure at Patriot Growth Capital. This article is educational only and does not constitute investment, legal, or financial advice.
Frequently Asked Questions
What is the working capital peg in a business acquisition?
The working capital peg is the agreed amount of working capital the seller must deliver with the business at close. Working capital is current assets minus current liabilities. If the business delivers above the peg, the buyer pays more. If it delivers below the peg, the purchase price decreases dollar for dollar.
How is the working capital peg typically calculated?
Most deals calculate the peg as the average working capital over the trailing twelve months, sometimes excluding months that reflect seasonal highs or lows. The lookback period choice alone can shift the peg by hundreds of thousands of dollars on a mid-size deal, because sellers prefer periods when working capital was low and buyers prefer periods when it was high.
What happens during the post-closing true-up process?
After closing, the buyer's accountants calculate actual working capital on the closing date balance sheet. If actual working capital falls below the agreed peg, the seller owes the difference to the buyer. If it exceeds the peg, the buyer pays the seller the excess. If the parties cannot agree on the calculation, they go to an independent arbitrating accountant at cost to both sides.
How do seasonal businesses complicate working capital peg negotiations?
The standard trailing-twelve-month average breaks down when a business has significant seasonal swings. A buyer closing in a seasonal low should not be penalized for a naturally reduced working capital balance, and a seller closing at a seasonal peak should not leave behind more working capital than they could extract again. The solution is a seasonally adjusted peg that normalizes to the expected level at the specific closing date.
