Net Working Capital Adjustment
The net working capital adjustment is the price adjustment for the working capital handed over. Actual working capital at the reference date is compared with a contractually agreed target, usually derived from the average of the last twelve months. The difference raises or lowers the purchase price directly.
A company is normally handed over cash-free and debt-free – but not working-capital-free. The buyer expects the business to come with its usual complement of receivables, inventory and payables, so that no cash has to be injected the day after completion. That is exactly what the net working capital adjustment governs.
How the target is set
The target, often called the peg, is the amount of working capital regarded as normal. The usual basis is the average of month-end balances over the last twelve months, sometimes twenty-four. In a seasonal business that average is dangerous: hand over in November, when receivables peak, and you deliver working capital above target and are paid for it; hand over in February and you pay in. Both effects can be calculated once the monthly series exists.
The boundary everything hangs on
Each item can fall either into working capital or into net debt. The difference is considerable: working capital is only measured against the target, whereas net debt is deducted from the price in full. Typical disputes are advance payments and deferred revenue in prepaid software models, holiday and overtime accruals, bonuses, committed capital expenditure and tax liabilities. An item may be counted only once – double counting is the classic error at the seller's expense.
The case that affects SaaS businesses
Under prepayment models the balance sheet carries deferred revenue, which economically is an obligation to perform. Buyers frequently argue this is net debt, because the service has to be delivered without further cash coming in. Sellers argue it is part of the ordinary course and belongs in working capital. In a fast-growing business that argument is quickly worth a seven-figure sum. The question belongs before signing, not in the completion balance sheet.
What to prepare
- working capital at each month-end over 24 months, on a defensible definition
- your own derivation of the target, adjusted for one-off effects
- a list of every item with a clear allocation to working capital or net debt
- knowledge of your own seasonal pattern – and, where possible, the choice of completion date to match
In a sale process what counts is not only the level but the consistency of the series: working capital squeezed down shortly beforehand does not lower the target, it shows up in the review. How the mechanism sits alongside locked box and closing accounts is set out there.