Most buyers negotiate the price and treat the working capital peg as a schedule someone will fill in later. Then the deal closes, a settlement statement arrives a couple of months on, and the number is not what anyone pictured at the closing table.
The peg is not paperwork. It is the seller’s promise about what the business still has in it the morning you take over, and it is one of the few places where diligence work converts directly into dollars you keep.
We do this work on buy-side financial due diligence engagements, usually right after proof of cash. What follows is how we think about the peg, the line items that move it more than buyers expect, and what the true-up looks like when it lands.
The Peg is a Promise About the Business, Not a Line in A Schedule
Working capital pegging sets an agreed closing balance of current assets minus current liabilities. If receivables, inventory, or deferred revenue deviate from that peg at close, the purchase price trues up in cash after the fact.
The reason the mechanism exists is simple enough. A business needs a baseline level of operating resources to run from day one, and without an agreed floor there is nothing stopping a seller from collecting hard on receivables, letting inventory run down, and stretching vendors in the weeks before closing. Every one of those moves converts something you thought you were buying into cash in the seller’s pocket.
One thing worth being clear about early: the line items that count are whatever your purchase agreement says they are. The definition is negotiated, not inherited from an accounting standard, and what goes in or comes out will move the number materially on a small deal. Walk the definition line by line before you sign, and take the drafting questions to your attorney rather than assuming the schedule is boilerplate.
That definition review is one piece of a broader pre-close process. If you’re still building out your acquisition checklist, the buy-side due diligence financial checklist we put together covers the full sequence of items buyers typically run through before the purchase agreement is signed.
How Do We Actually Set The Peg?
We start with the cash conversion cycle, because that is what determines how much operating cushion the business genuinely needs. A trailing average smooths out the noise, but the average only means something once you understand how long the business waits between paying for something and getting paid for it.
The gap between two businesses here is wider than most buyers expect. For a well-run e-commerce operation the cycle is fast, and a peg in the neighborhood of one to two weeks of average monthly sales is a reasonable starting point. For most of the businesses we diligence, one full conversion cycle runs several months, which means a materially larger peg for the same revenue.
Seasonality gets handled in the same pass. A landscaping company and a ski rental shop both look wildly different depending on which month you snapshot, so a single closing-date balance tells you almost nothing about what the business normally carries.
Three Line Items Move The Number More Than Buyers Expect
The traps we see most often are gift cards, deferred revenue, and inventory payables. Each one is easy to skim past, and each one can move the number meaningfully at the closing table.
Gift cards come in two flavors, and they behave differently. Cards a customer paid cash for sit on the balance sheet as a liability you are acquiring. Cards the seller gave away as a promotional incentive are a different animal, because they were used to drive conversions, which means reported revenue already carries the effect of the promotion, and the unredeemed balance is still an obligation if you keep honoring it.
On one e-commerce diligence, we found a six-figure promotional gift card balance with redemptions running at a small fraction of it. Sellers will argue a low take rate makes the balance immaterial. We push back, because federal law requires these cards to stay valid for at least five years from issuance or the last load, and the redemptions that do land carry real product and shipping cost.
Deferred revenue is the one buyers most often treat as a liability to fear. If the seller pre-billed for services not yet delivered, subscriptions or annual packages or anything similar, you are inheriting the obligation to perform, which reduces normalized earnings and belongs in the peg. There is a second half to it that cuts the other way: the seller already paid tax on cash you will recognize as revenue, so the position has a value to you roughly equal to that balance at your own rate. Price both halves rather than only the scary one.
Inventory payables round out the list. Goods sitting on the shelf and the bill for those same goods have to be measured on the same date, or the peg quietly counts the asset without the liability.
The Cash Conversion Cycle is Where The Peg Gets Decided
We worked with a buyer looking at a trade show business where vendors were paid upfront and the business collected revenue at the end of the show cycle. On the surface, the margins looked fine. The working capital picture was a mess because the timing gap never showed up anywhere on the profit and loss statement.
That is the case for doing this work before the peg is agreed rather than after. A profit and loss statement tells you whether the business makes money. It does not tell you how much cash has to sit inside the business permanently for it to keep operating.
It is also why we run proof of cash first. Reconciling bank accounts, cards, receivables, payables, owner draws, and contributions against the reported numbers is what confirms the figures are real, and the peg calculation is downstream of that answer. If you are relying on the SBA lender’s review to catch this, it will not. That review protects the bank.
What Happens When The True-Up Statement Lands?
After close, someone prepares a closing balance sheet on the accounting principles the purchase agreement specifies, the other side reviews it, and the difference from the peg settles in cash. Small deviations usually fall inside a threshold so nobody litigates normal business noise, and a portion of the seller’s exposure often sits in escrow until the number is final.
The timeline runs longer than first-time buyers plan for. Between preparing the statement, the review window, and a negotiation period if the two sides disagree, a straightforward true-up commonly takes a few months from closing, and a contested one takes longer.
Most purchase agreements send genuine disputes to a neutral accounting firm that rules on the contested items only. That is a reasonable backstop and an expensive way to resolve something that a clear definition would have prevented.
Receivables Are Where The True-up Turns Into An Argument
Aging is the usual flashpoint. If the agreement includes receivables without specifying a cutoff, the buyer argues that long-stale invoices are effectively uncollectible while the seller treats them as real assets the business has always carried. Both readings can be defensible, which is exactly the problem.
Collections create the other mess, and it is a practical one rather than a drafting one. After close, customers keep paying the account they have always paid. We worked a purchased receivables reconciliation where a meaningful sum landed in the seller’s old account before anyone noticed, and the seller had to remit it back.
A reconciliation template set up on day one prevents that from becoming an argument in month three. It also gives you something better than memory when the settlement statement shows up. Purchase accounting is not locked the morning after closing either, so tracking what actually collects and truing up when the picture is complete is a legitimate approach rather than a correction.
Why Does The True-Up Reach Your Tax Return?
Because a settlement after close changes the consideration, and consideration drives the asset allocation both sides already reported. The IRS instructions for Form 8594 put it directly: if the amount allocated to any asset is increased or decreased after the year of the sale, the seller and purchaser must file a supplemental Form 8594 with the return for the year the change is taken into account.
Buyers rarely find this out at the right moment. The true-up gets treated as a cash settlement between two parties, the accountant sees it months later, and the allocation quietly no longer matches what was filed.
Worth flagging to whoever prepares your return before the settlement is final, not after.
Getting The Peg Right Is Diligence Work, Not Paperwork
A well-set peg is not a buyer-friendly number or a seller-friendly one. It is an honest read of what a normally operating version of this business has to carry, and when it is set that way the true-up is usually small and settles without a fight.
That work belongs in the diligence phase, while the letter of intent is still being negotiated and the language is still moveable. A quality of earnings review normalizes working capital for seasonality, flags the items that distort the trailing average, and gives you a basis for the peg that both sides can actually agree on. Some buyers only need the working capital piece done properly rather than the full engagement.
If you have a target under letter of intent, or you are sixty days past closing and a true-up statement just landed in your inbox, reach out to Ashford Sky and we will work through the numbers with you.
