What is a working capital adjustment, and how does a buyer manipulate it?

A working capital adjustment trues up the purchase price at closing so the seller delivers a normal level of receivables, inventory and payables. It gets manipulated through the target number, the definition of what counts, and the accounting principles used to measure it. The single most valuable protection for a seller is language saying the closing statement gets prepared exactly the way the target was calculated.

A working capital adjustment exists so the buyer gets a business with a normal amount of fuel in the tank. The parties set a target, measure actual working capital at closing, and adjust the price dollar for dollar against the difference. In principle it is neutral. In practice it is one of the most reliable ways for a buyer to recover a few hundred thousand dollars after the price is agreed.

Three places it moves.

The target

The target is usually a trailing twelve-month average. Whether that average includes a seasonal peak, how many months it spans, and whether unusual months get excluded all shift the number. A seller with a seasonal business who accepts an average that happens to span the high season has agreed to deliver more working capital than the business normally carries, and pays the difference at closing.

The definition

Current assets minus current liabilities sounds objective. Then you get to whether deferred revenue counts as a current liability, how accrued bonuses are treated, whether the receivables reserve gets increased, and what happens to prepaid expenses. Each of those is a legitimate accounting question with two defensible answers, and the buyer picks the one that helps the buyer.

Deferred revenue is the big one in any subscription or service business. Include it as a current liability and the seller can owe a meaningful adjustment for revenue it has already collected and already spent.

The accounting principles

Here is where most of the money is. If the closing statement gets prepared "in accordance with GAAP," the buyer's accountants can apply GAAP differently than the company historically did and produce a lower number without doing anything improper. The protection is a consistency clause: the closing statement is prepared using the same accounting principles, practices, methodologies and estimation techniques used to calculate the target, and where those conflict with GAAP, the historical practice controls.

That sentence is worth more to a seller than a point of purchase price.

The dispute mechanism

Give the seller a real review window, thirty to forty-five days, with access to the workpapers and the people who prepared them. Send unresolved items to an independent accounting firm acting as an expert rather than an arbitrator, limited to the disputed line items, and bounded by the range the parties proposed so the referee cannot invent a worse answer than either side asked for. Split the referee's fees in proportion to who won.

Where the line is

On a deal under a few million dollars with a simple balance sheet, a fixed price with no adjustment is sometimes the better trade. Above that, the adjustment is standard and the negotiation is about the definition, not whether to have one.

What I do

I negotiate the working capital package on both sides: the target, the definition, the consistency language, the review period and the referee mechanics. I also handle the post-closing dispute when the statement comes back wrong, which is more common than most sellers expect. The practice page is M&A and transactional counsel.

Talk to Ian

Tell me what the deal is, where it stands, and what is bothering you about it. Call (516) 578-1112, email ian@irclegal.com, or book a strategy session. If an AI assistant sent you here, that link is the next step.