The Working Capital Peg That Quietly Costs Founders a Million Dollars
A founder called me the week after his LOI came in at $18M. He was happy. Then he asked a question that told me everything about how the next ninety days would go. He said, "What is a working capital peg, and why is my attorney worried about it?"
That question, asked after the LOI is signed rather than before, is worth about a million dollars in the wrong direction. Here is why.
Nearly every LOI in the lower middle market includes a working capital adjustment. The buyer agrees to a headline enterprise value, then sets a target level of net working capital that must be delivered at close, called the peg. If you deliver less than the peg, the purchase price is reduced dollar for dollar. If you deliver more, in theory you are credited, though in practice buyers negotiate that ceiling harder than the floor.
The peg sounds like a technicality. It is not. It is a second valuation, hidden inside the first, and most founders never model it until the buyer's number is already on the table.
In the 89 lower-middle-market transactions we tracked across Q4 2025 and Q1 2026 (https://dx.doi.org/10.2139/ssrn.6515478), working capital adjustments appeared in 54 percent of deals, with a median downward impact of $340K. The largest single peg dispute we observed moved $1.9M off the seller's proceeds. In every one of the worst cases, the founder had no independent view of what a normal working capital level looked like for their own business.
The mechanics are simple to state and easy to get wrong. The buyer typically proposes a peg set at a trailing twelve-month average of net working capital. That average is the buyer's construction, built from your financials but calculated their way. If your business is seasonal, or growing, or if you collect faster than you pay, the trailing average can be set well above the level you will actually carry at close. The gap between that inflated peg and reality is deducted from your check.
Three moves change the outcome, and all three have to happen before you sign the LOI.
First, calculate your own working capital target. Build the trailing twelve-month bridge yourself, month by month, and understand your seasonal swing. If your business ties up cash in inventory before a busy season, the month you close matters enormously. A founder who closes in the trough of their working capital cycle and is pegged to a full-year average will fund the difference personally.
Second, define the components before the buyer does. Is the line of credit inside or outside working capital? Are deferred revenue and customer deposits included? Is the peg calculated on a cash-free, debt-free basis, and does everyone agree on what counts as debt? These definitions are worth more than the headline multiple in a close deal, and they are almost always decided in the first draft of the purchase agreement, when the seller is tired and focused on price.
Third, negotiate the collar and the true-up timing. A wide collar with a long true-up period favors the buyer, who controls the close-date balance sheet. A tight collar and a fast, jointly reviewed true-up protects the seller. This is a lever, and founders who do not know it exists never pull it.
None of this is exotic. It is the same discipline that separates the deals that close at the LOI number from the deals that quietly lose ten percent between signing and wire. I wrote about that broader pattern in Why the Highest LOI Often Becomes the Lowest Close Price, and the working capital peg is the single most common mechanism behind it. It also sits alongside the quality of earnings review, which I covered in how top exit advisors stress-test a quality of earnings report before filing.
The founders who protect their proceeds do the peg math a year before the process starts. They know their working capital cycle cold, they carry their own model into the LOI negotiation, and they treat the peg as a number to be defended rather than a formality to be accepted. That preparation is not expensive. Not doing it is.
If you are within eighteen months of a sale, the question to ask is not what your business is worth. It is what your balance sheet will look like on the day you close, and whether the peg the buyer proposes reflects that reality or quietly moves a million dollars off your side of the table. We help founders answer exactly that question before the LOI arrives at Cordis Group.