Of all the mechanics buried in a purchase agreement, working capital adjustments are among the most likely to surprise a first-time buyer or seller — and among the most likely to generate a dispute after closing. The concept is simple in theory and easy to get wrong in practice.
Why deals aren't priced on a "cash-free, debt-free" basis alone
Most middle-market deals are priced on a "cash-free, debt-free" basis: the buyer isn't paying for the seller's cash, and the seller isn't expected to deliver the business debt-free out of pocket — debt gets paid off at closing out of proceeds. But that convention alone doesn't account for the working capital the business needs to keep operating normally — inventory, receivables, payables and accrued expenses that fluctuate with the ordinary rhythm of the business. That is what the working capital adjustment is designed to handle.
Setting the target
Buyer and seller typically negotiate a target working capital level — often based on a trailing 12-month average, adjusted for seasonality or known anomalies. The purchase agreement then provides that if working capital at closing comes in above the target, the seller receives a dollar-for-dollar increase to the purchase price; if it comes in below, the buyer receives a reduction. The goal is to make the buyer indifferent to the exact working capital level at closing, while ensuring the business is delivered with enough operating liquidity to function normally on day one.
Estimate now, true up later
Because it is rarely practical to calculate exact working capital on the closing date itself, most deals use a two-step mechanism: an estimated adjustment at closing, based on the most recent available financials, followed by a post-closing "true-up" once a final working capital statement is prepared — typically within 60 to 90 days. If the final number differs from the estimate, the purchase price is adjusted accordingly, sometimes drawn from an escrow set aside for exactly this purpose.
Working capital disputes are rarely about big, obvious numbers — they're about definitions: what counts as a current liability, how inventory is valued, whether a disputed receivable should be included at all.
Where disputes actually happen
The mechanism sounds mechanical, but the definitions underneath it are where most disagreements arise. Common flashpoints include how slow-moving or obsolete inventory is valued, whether certain accrued liabilities (like bonuses or unused vacation) are included, how deferred revenue is treated, and whether one-time or non-recurring items should be excluded from the target calculation. A purchase agreement that defines these terms precisely — and specifies exactly which accounting methodology and consistent practices apply — heads off most disputes before they start.
When buyer and seller disagree
Most purchase agreements provide a structured process for resolving disagreement over the final working capital statement: an objection period, a negotiation window, and — if the parties still can't agree — referral to an independent accounting firm whose determination is typically final and binding. Knowing this process exists, and how it works, before a dispute arises makes it far less stressful when (or if) one occurs.
The bottom line
Working capital adjustments exist to protect both sides from an artificially stripped-down or artificially loaded balance sheet at closing. Getting the target, the definitions and the true-up mechanism right at the letter-of-intent and purchase-agreement stage is one of the more technical parts of a deal — and one where a few hours of careful negotiation up front can prevent a much longer dispute later.
