Exit Planning
Working Capital When Selling a Manufacturing Business: The Peg, True-Up, and Your Proceeds
Free Business ValuationIn most manufacturing sales, the buyer expects a normal level of working capital to be left in the business at closing. That level is the peg. If the receivables, inventory and work in process delivered at closing come in below the peg, the price drops dollar for dollar. If they come in above it, the seller is usually paid the difference. For a manufacturer, that adjustment can be one of the largest numbers in the deal after the price itself.
Owners tend to focus on the multiple. Buyers focus on the multiple and the working capital, because a manufacturer cannot ship next month’s orders without inventory on the shelves, jobs on the floor and receivables coming in. The buyer is paying for a business that works on day one, and the working capital is what makes it work.
This guide explains what working capital means in a deal, how the peg is set, how the true-up after closing works and where manufacturing sellers usually lose money. The example is hypothetical and uses round numbers.
What working capital means in a manufacturing deal
In a transaction, working capital usually means the operating current assets minus the operating current liabilities, excluding cash and debt. It is narrower than the accounting definition on a balance sheet, and the purchase agreement defines exactly which accounts count.
| Usually included | Usually excluded | Often negotiated |
|---|---|---|
| Accounts receivable from customers | Cash, which the seller typically keeps in a cash-free deal | Customer deposits and progress billings |
| Raw materials, work in process and finished goods | Bank debt, lines of credit and equipment loans, which are paid off | Obsolete or slow-moving inventory reserves |
| Prepaid expenses that benefit the business after closing | Income taxes owed by the seller | Accrued bonuses and vacation pay |
| Accounts payable to suppliers | Transaction fees | Customer-owned tooling and consigned material |
| Accrued wages and other normal operating liabilities | Amounts owed to the owner or related parties | Warranty reserves |
Most lower-middle-market deals are priced on a cash-free, debt-free basis. The seller keeps the cash and pays off the debt, and the buyer receives a normal level of working capital. That is why working capital is negotiated separately from the headline price.
How the peg is set
The peg is the amount of working capital both sides agree is normal for the business. Buyers usually start with an average of monthly working capital over the trailing 12 months, then adjust it for unusual items and for where the business is heading.
The details of that average decide the outcome:
- The period. A trailing 12-month average smooths seasonality. A shorter period, or one that ends at a seasonal high, can push the peg up.
- Monthly closes. If the company only books inventory and WIP accurately at year end, the monthly figures used for the average may be unreliable. Buyers will either rebuild them or pick the most conservative view.
- Growth. A growing manufacturer carries more receivables and inventory each month. A buyer may argue the peg should reflect current volume, not last year’s average.
- One-time items. A large prepayment, a stockpile of material bought ahead of a price increase or a slow-paying customer can distort the average in either direction.
The seller’s goal is not the lowest possible peg. It is a peg that reflects how the business actually runs, supported by monthly records the buyer cannot easily dispute.
Worked example: how the true-up changes the check
The example below is hypothetical. It shows a contract machining company sold for $12,000,000 on a cash-free, debt-free basis.
The buyer and seller agree on a working capital peg of $2,400,000, the average of the last 12 monthly closes. At closing, the parties use an estimate of working capital, and the final number is calculated after closing, by a deadline the purchase agreement sets, with a period for the other side to review and object.
| Account at closing | Estimated at closing | Final after true-up | What changed |
|---|---|---|---|
| Accounts receivable | $1,650,000 | $1,560,000 | A $90,000 invoice in dispute with a customer is excluded. |
| Inventory and work in process | $1,450,000 | $1,300,000 | The buyer’s count values $150,000 of slow-moving stock at zero. |
| Accounts payable and accrued expenses | −$700,000 | −$760,000 | A late supplier invoice and accrued vacation are added. |
| Working capital delivered | $2,400,000 | $2,100,000 | Final working capital is $300,000 below the peg. |
The seller expected working capital to match the peg exactly. The true-up shows a $300,000 shortfall, and the seller owes that amount back to the buyer, often from an escrow set aside at closing. On a $12 million deal, that is 2.5% of the price lost to three items the seller could have cleaned up before going to market.
Reverse the facts and the seller can come out ahead. If the business delivers $2,600,000 at closing because receivables are strong, the seller is usually paid $200,000 more, if the agreement allows upward adjustments. Check that it does.
Where manufacturing sellers lose money on working capital
| Problem | How it shows up | What to do before a sale |
|---|---|---|
| Inventory not counted or costed consistently | The buyer’s count or costing produces a lower value than the books. | Run regular physical counts, reconcile them to the general ledger and write down obsolete stock yourself. |
| WIP estimated only at year end | Monthly WIP swings make the average unreliable, so the buyer chooses a conservative number. | Book WIP monthly from job-costing records using a consistent method. |
| Old or disputed receivables | Old or disputed balances may be reserved against or excluded, depending on the collectibility rules in the agreement. | Collect, settle or write off old balances, and document customer payment terms. |
| Customer deposits not tracked | Deposits for unshipped work are treated as a liability the buyer inherits, which lowers working capital. | Track deposits and progress billings by job and match them to the work still to be done. |
| Inventory built up before closing | Buying extra stock raises working capital, but if the peg also rises the seller gains nothing and may have spent cash. | Keep buying patterns normal in the months before a sale, and agree on how one-time purchases are treated. |
| Owner-related balances | Loans to or from the owner are mixed into operating accounts. | Clear or separate owner and related-party balances before the trailing period begins. |
Inventory and work in process are usually the hardest part of a manufacturer’s working capital to support. Our guide to how inventory and WIP affect a manufacturing business sale covers the counting, costing and double-counting issues in more detail.
What to negotiate in the LOI and purchase agreement
The working capital terms should be agreed as early as possible, ideally in the letter of intent. A vague promise to deliver “normal working capital” lets the buyer define the number after exclusivity starts, when the seller has less leverage.
- The peg or the method: a dollar figure, or at least the months averaged and the accounts included.
- Accounting principles: working capital at closing should be measured the same way it was measured for the peg. Changing methods between the two is a common source of disputes.
- Two-way adjustment: the seller should be paid for excess working capital, not only charged for a shortfall.
- A collar: some deals ignore small differences within an agreed band to avoid fighting over minor amounts.
- The dispute process: who prepares the closing statement, how long the other side has to object, and which independent accountant decides if the two sides cannot agree.
- The escrow: how much is held back for the adjustment and when it is released.
Our guide to selling a manufacturing business includes a broader LOI checklist.
How to prepare in the 12 months before a sale
- Close the books monthly, including inventory and WIP, so a reliable 12-month history exists when buyers ask for it.
- Calculate your own peg using the same definitions a buyer would use, and understand the seasonal pattern.
- Clean up receivables: collect old balances, resolve disputes and write off what will not be collected.
- Count and value inventory and reserve for slow-moving or obsolete stock before a buyer does it for you.
- Separate owner items from operating accounts.
- Keep operations normal in the run-up to closing. Unusual buying, billing or collection patterns get noticed.
Frequently asked questions
What is a working capital peg?
A working capital peg is the target level of working capital the seller agrees to deliver at closing. If the working capital delivered is below the peg, the purchase price is usually reduced by the difference. If it is above, the seller is usually paid the difference, if the agreement allows it.
Is working capital included in the purchase price?
Usually yes, in the sense that a normal level of working capital is expected to stay in the business as part of the price. The seller is not paid extra for delivering that normal level. Cash and debt are usually handled separately on a cash-free, debt-free basis.
How is the peg calculated?
It is often based on the average of monthly working capital over the trailing 12 months, adjusted for unusual items and sometimes for growth. The purchase agreement defines which accounts are included and how they are measured.
What is a working capital true-up?
A true-up is the calculation after closing that compares the working capital actually delivered with the peg. The difference is paid by the seller or the buyer, often through an escrow. The timing and dispute process are set in the purchase agreement.
Why is working capital harder for manufacturers?
Manufacturers usually carry significant inventory, work in process and receivables, and those balances can be difficult to count, cost and support month by month. Weak inventory or job-costing records give the buyer room to argue for a lower value.
Want to know your working capital position before a buyer calculates it? Start with a free, confidential manufacturing valuation. We review earnings, working capital and the other terms that decide what you actually receive.
This article is general educational content for business owners. It is not legal, tax, accounting or transaction advice. Working capital terms are deal-specific and should be reviewed with qualified advisors.
