When business owners consider selling their company, they tend to focus on valuation multiples, EBITDA, and the purchase price. But there is another component of a transaction that often surprises sellers and can meaningfully affect the final proceeds they receive:
Working capital.
Many transactions that appear straightforward on the surface become more complicated during the final weeks before closing: not because of price negotiations, but because of disagreements about working capital.
Understanding how working capital functions in a sale can prevent confusion, frustration, and unnecessary value erosion.
What Is Working Capital?
At its simplest, working capital is:
Current assets minus current liabilities.
In most operating businesses, that includes:
- Accounts receivable
- Inventory
- Prepaid expenses
- Accounts payable
- Accrued expenses
Working capital represents the short-term liquidity required to operate the business day to day. It is the fuel that keeps the company moving between revenue cycles.
In the context of a sale, however, working capital is often defined more narrowly to most closely reflect the true operating working capital. From there, it becomes a big component in the overall transaction structure.
Why Buyers Care About Working Capital
When a buyer acquires your company, they are purchasing a functioning business, not just its historical earnings.
They expect the business to be delivered with a “normal” level of working capital sufficient to continue operations immediately after closing.
In other words:
If your company typically needs $5 million of working capital to operate smoothly, the buyer expects to receive the company with approximately that amount at closing.
If working capital is materially below that level, the buyer may require a purchase price adjustment.
The Concept of a “Working Capital Target”
Most transactions establish a working capital target (or peg) during diligence.
This target is typically calculated by averaging historical monthly working capital balances over roughly the last 12 months, adjusted for seasonality and structural changes where appropriate.
The logic is straightforward:
- If working capital at closing equals the target, there is no adjustment.
- If it falls below the target, the purchase price is reduced dollar-for-dollar.
- If it exceeds the target, the seller receives an upward adjustment.
This mechanism ensures that the buyer receives a business with the liquidity it normally requires to operate.
Where Sellers Can Get Surprised
Working capital adjustments are rarely intuitive for owners, especially founder-led businesses.
Common reactions include:
- “But that’s my cash.”
- “I already earned those receivables.”
- “Why does inventory matter if I’m selling the business?”
The answer is that buyers are not paying for the business twice.
They are purchasing:
- The enterprise value (based on earnings), and
- A normalized level of working capital to sustain those earnings.
If working capital is artificially low at closing, the buyer effectively funds the shortfall.
The Most Common Working Capital Issues in Transactions
Understanding common pitfalls can help owners prepare in advance.
1. Inventory Management
In inventory-heavy businesses, fluctuations can be significant.
If inventory has been reduced before closing, the working capital calculation may reflect a shortfall.
Buyers will normalize inventory to historical operating levels, not temporary reductions.
2. Receivables Collection
Accelerating collections before closing may temporarily boost cash on hand, but it reduces accounts receivable.
From the buyer’s perspective, the business now has fewer receivables than normal, and that difference may reduce the purchase price through a working capital adjustment.
3. Stretching Payables
Delaying payments to suppliers can artificially increase working capital on paper.
Buyers scrutinize payable aging carefully. If payables are unusually high, they may adjust the target downward or challenge the calculation.
4. Seasonality
Seasonal businesses can experience significant swings in working capital throughout the year.
If a transaction closes at a seasonal low or high point, adjustments can become contentious unless the target has been thoughtfully structured.
5. Inconsistent Accounting Practices
If financial reporting has not been consistent, working capital calculations become more complicated.
For example:
- Reclassifying expenses
- Changing accrual timing
- Altering inventory accounting methods
These changes can materially affect target calculations and delay closing.
How Working Capital Affects Real Proceeds
Consider this simplified example:
- Agreed enterprise value: $50 million
- Working capital target: $6 million
- Actual working capital at closing: $5 million
The buyer would typically reduce the purchase price by $1 million.
The headline price may remain $50 million, but the seller receives $49 million at closing.
In other words, working capital is not theoretical. It directly impacts proceeds.
Preparing for Working Capital Discussions Early
One of the most effective ways to avoid surprises is to analyze working capital before going to market.
Owners should understand:
- What their normalized working capital truly is.
- How volatile it has been.
- How seasonality affects it.
- Whether recent operational decisions have distorted it.
Preparing this analysis early allows you to:
- Set realistic expectations.
- Anticipate buyer questions.
- Structure timing appropriately.
- Avoid emotional reactions late in the process.
Enterprise Value vs. Equity Value
Another important distinction: Enterprise value reflects the value of the operating business.
Equity value is what the seller ultimately receives after adjusting for:
- Debt
- Cash
- Working capital
- Transaction expenses
Many sellers focus on enterprise value without fully understanding how these adjustments convert to net proceeds.
Western’s Perspective
Working capital is rarely the most exciting part of a transaction, but it is often one of the most important and most misunderstood.
In our experience, friction around working capital typically stems from:
- Lack of preparation.
- Inconsistent financial reporting.
- Emotional attachment to short-term balances.
- Or misunderstandings about how buyers structure deals.
Our role is to ensure that owners understand the mechanics of working capital well before the final weeks of a transaction.
When handled properly, working capital should be a neutral adjustment rather than a source of conflict.
Conclusion
Working capital is not a hidden fee or a buyer trick. It is a mechanism designed to ensure that a business transfers in a stable, operationally ready condition.
The more predictable and transparent your working capital profile, the smoother the transaction will be.
If you are considering a sale, take time to understand how your business’s working capital behaves. Because in the final stages of a deal, agreement on working capital can make the difference between a seamless closing and an avoidable dispute.
About Western
Western Commerce Group is a family-owned M&A and strategic advisory firm with a 25-year track record of guiding business owners through complex transitions with discretion and care. We build lasting relationships so that when the time is right, our clients have a trusted advisor who understands their goals and values their company’s legacy. To date, we have assisted over 160 clients throughout North America and facilitated more than $13 billion in transactions.
Interested in learning more about what it would look like to sell your business or know someone who is looking for such guidance? Please reach out to us at www.western-companies.com/start-the-process.