Working capital peg
The normal level of working capital a deal assumes will be left in the business at closing. Delivering above or below it adjusts the price.
In more detail
A business needs a certain amount of cash tied up in receivables and inventory, less what it owes suppliers, just to keep operating. The peg is the agreed normal level, usually an average of recent months to smooth out seasonality. At closing, actual working capital is measured against the peg and the price moves dollar for dollar. Without a peg a seller could collect every receivable and pay no bills on the way out, handing over a business that cannot make payroll.
For example
The peg is set at $400,000, the twelve-month average. At closing, actual working capital is $355,000, so the purchase price is reduced by $45,000.
If you are selling
Set the peg on an honest average and understand the seasonality behind it. A peg struck at your seasonal high costs you real money at closing.
If you are buying
The peg protects you from inheriting a business that has been drained. Insist the calculation and the measurement date are defined precisely in the agreement.
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