What is a working capital adjustment in a business sale?
A working capital adjustment is a post-closing purchase price mechanism that increases or decreases the final sale price based on the actual working capital delivered at closing compared to a target amount established when the deal was signed. Working capital is calculated as current assets minus current liabilities, and in cash-free, debt-free transactions, the adjustment ensures the buyer receives sufficient working capital to operate the business post-closing.
How the adjustment mechanism works
The working capital adjustment typically uses a target working capital amount established at signing, with the final purchase price adjusted up or down based on actual working capital at closing. The target working capital is commonly set as the average or normalized working capital level from the trailing 12 months prior to signing.
If the actual working capital at closing is higher than the target, the buyer pays more. If it's lower, the buyer pays less. This mechanism protects buyers from receiving a business stripped of necessary operating assets, and protects sellers from leaving excess working capital in the business without receiving credit for it.
Common calculation methods
Cash and interest-bearing debt are typically excluded from working capital calculations in M&A transactions. The purchase agreement includes a detailed schedule defining which accounts are included in the working capital calculation to prevent disputes — accounts receivable, inventory, prepaid expenses, accounts payable, and accrued liabilities are commonly included, while cash, lines of credit, and term debt are excluded.
Some agreements include a collar or threshold below which no adjustment is made, typically ranging from 5-10% of the target working capital amount. This prevents minor fluctuations from triggering adjustments and reduces administrative burden.
The true-up process at closing
At closing, the parties prepare a preliminary working capital statement based on the most recent financial information available. This preliminary figure determines the initial purchase price payment. Because final accounting often requires more time to complete accurately, the parties agree to a post-closing true-up process.
Typical post-closing adjustment periods
Post-closing working capital adjustment periods typically range from 60 to 90 days after closing. During this period, the buyer prepares a final working capital statement, which the seller has an opportunity to review and dispute. If the parties cannot agree on the final working capital figure, the purchase agreement typically provides for resolution through an independent accounting firm or business valuator.
Accounting firms or independent business valuators are commonly engaged to resolve disputes over the final working capital calculation when the parties cannot reach agreement through negotiation.
Common disputes and how to avoid them
Disputes over working capital adjustments account for approximately 25-30% of post-closing purchase price disputes in middle-market transactions, according to the SRS Acquiom M&A Deal Terms Study. Common points of contention include:
- Which accounts should be included in the working capital calculation
- How to classify borderline items (are certain prepaid expenses truly current assets?)
- Whether certain reserves or accruals were appropriate
- The accounting policies used to prepare the final statement
According to Osler Hoskin & Harcourt LLP's Private M&A in Canada Deal Terms Report, sellers often push for wide collars or no working capital adjustment mechanism to reduce post-closing exposure, while buyers prefer tight mechanisms to ensure operational continuity.
To minimize disputes, purchase agreements should define the working capital calculation methodology in detail during negotiation — not after closing. The agreement should specify which accounts are included, the accounting policies to be applied, and whether a collar or threshold applies. Both parties benefit from having their accounting advisors review and negotiate the working capital schedule before signing.
Working capital adjustment mechanisms are more common in asset sales and middle-market transactions than in larger private equity deals, where locked box mechanisms are increasingly used.
This article is for informational purposes only and does not constitute financial, legal, or business advice. Every business sale is different. Before making decisions about purchase price mechanisms or engaging an advisor, consult a qualified professional familiar with your specific situation.
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