Working capital is where upper middle market transactions leak value. The LOI states a purchase price. The closing statement reveals what the acquirer actually paid. The difference is often working capital — and the acquirer who did not examine the peg discovers they funded the target's operations rather than acquiring them.
This article maps the institutional methodology for buy-side working capital examination: why the peg matters, how acquirers establish normalized levels, and the examination architecture that protects acquirer economics in upper middle market transactions.
Buy-side working capital examination determines whether the proposed peg reflects the capital required to operate the acquired business. Institutional acquirers analyze 24 to 36 months of trailing data, adjust for seasonality and one-time items, and establish normalized levels that protect against post-close value leakage. Working capital adjustments represent 8 to 18 percent of purchase price in upper middle market transactions.
Working capital is the capital required to operate the business day-to-day: accounts receivable, inventory, and prepaid expenses less accounts payable and accrued expenses. The working capital peg in a purchase agreement establishes how much of that capital the seller leaves in the business versus extracts as part of the purchase price.
The economic mechanics
Arithmetic illustration — not a client engagement: a target operates with $50 million in normalized working capital. The seller proposes a $35 million peg. If the acquirer accepts:
The working capital peg is not an accounting detail. It is a direct transfer of value between buyer and seller that compounds into permanent capital deployment.
The six-step working capital examination methodology, from defining the calculation basis through the trailing analysis, seasonality, one-time adjustments, the normalized level, and the true-up mechanism that protects acquirer economics.
Define precisely which current assets and current liabilities constitute working capital for the transaction, excluding cash, funded debt, income taxes, and intercompany balances, because small definitional differences create material peg differences.
Calculate working capital monthly over 24 to 36 trailing months to reveal the seasonality, trend, and volatility pattern that determines the appropriate peg methodology.
| Month | AR | Inventory | Prepaid | AP | Accrued | Net WC |
|---|---|---|---|---|---|---|
| Jan-24 | $42M | $28M | $6M | ($24M) | ($12M) | $40M |
| Feb-24 | $45M | $26M | $5M | ($22M) | ($13M) | $41M |
| … | … | … | … | … | … | … |
| Dec-25 | $58M | $34M | $8M | ($21M) | ($14M) | $65M |
Map seasonal highs and lows across the trailing period so the peg reflects normalized levels rather than a snapshot that favors one party.
| Quarter | Average WC | vs. Annual Avg |
|---|---|---|
| Q1 | $42M | -12% |
| Q2 | $48M | +0% |
| Q3 | $56M | +17% |
| Q4 | $44M | -8% |
| Annual Average | $48M | — |
A seller who proposes a peg based on Q3 (seasonal high) captures $8 million more than the annual average. A seller who proposes a peg based on Q1 (seasonal low) sets the peg $6 million below the annual average. A trailing twelve-month average may hide a swing of more than $14 million between seasonal high and low.
Identify transient distortions such as receivable spikes from large orders, project-specific inventory builds, stretched payables, and prepaid anomalies, and adjust each to reach the normalized level.
Set the ongoing working capital requirement using 24-month trailing data adjusted for one-time items and normalized to the projected close month's seasonal pattern.
Negotiate the adjustment mechanics, favoring dollar-for-dollar adjustment without a collar, and define the dispute resolution process for closing working capital.
Arithmetic Illustration — an upper middle market transaction in the $300M to $600M enterprise value range. Not a client engagement or a calculation for any specific company. The methodology, not the snapshot, moves the peg.
| Analysis Element | Seller Proposal | TEOL Examination | Difference |
|---|---|---|---|
| Methodology | TTM Snapshot | 24-Month Normalized | — |
| Snapshot Date | Dec (Seasonal Low) | Seasonal Adjusted | — |
| Proposed / Normalized | $38M | $52M | +$14M |
| One-Time Adjustments | None identified | ($3M) inventory build | — |
| Final Peg | $38M | $49M | +$11M |
Each tactic has an institutional counter. The acquirer who anticipates the tactic negotiates from the defensible position.
Seller proposes a peg based on trailing twelve months that happen to include a seasonal low or cash-preservation period.
Require 24-month trailing analysis with seasonal adjustment.
Seller proposes excluding "unusual" months that happen to show higher working capital requirements.
Require consistent methodology — if months are excluded, the exclusion criteria must be documented and applied consistently.
Seller proposes a definition that excludes items — customer deposits, deferred revenue — that reduce working capital.
Negotiate a comprehensive definition that reflects the actual capital required to operate.
Seller proposes a significant collar of $5 million or more that allows working capital extraction within the band.
Negotiate dollar-for-dollar adjustment or a minimal collar.
Seller defers working capital negotiation until late in diligence, when deal momentum creates pressure to close.
Establish the peg methodology in the LOI or immediately post-LOI, before commitment pressure builds.
TEOL's working capital examination integrates with buy-side QofE as a unified diligence work stream.
TEOL builds the complete trailing analysis from source data — general ledger exports, not management summaries — ensuring accuracy and completeness.
TEOL maps the seasonal pattern with statistical analysis, identifying whether apparent seasonality is consistent year-over-year or represents one-time variation.
TEOL identifies one-time items through inquiry and corroboration, adjusting the normalized calculation and documenting each adjustment.
TEOL produces a working capital memorandum documenting the methodology, analysis, and recommended peg — providing the acquirer with a defensible position for negotiation.
TEOL recommends true-up mechanisms that protect acquirer economics while remaining commercially reasonable.
Working capital examination is not a closing mechanic. It is the analysis that determines whether the purchase price you agreed to is the purchase price you pay.