01 Jun The Working Capital Adjustment: How Buyers Legally Take Back Hundreds of Thousands After You’ve Already Closed
You sold your business. The wire hit your account. You took your family to dinner, opened a bottle of something expensive, and felt, for the first time in months, like you could breathe.
Then, sixty days later, your buyer’s accountant sent a letter. The working capital at closing was $340,000 below the agreed target. Under the terms of the purchase agreement, you owe the buyer $340,000 back.
You didn’t steal anything. You didn’t breach a representation. You simply ran your business the way you always had. But the way you always had wasn’t the way the purchase agreement defined working capital, and that gap just cost you a significant chunk of your sale proceeds.
What Working Capital Actually Means in a Deal
Working capital, at its simplest, is current assets minus current liabilities. Cash, receivables, and inventory on one side. Payables, accrued expenses, and short-term obligations on the other. The buyer needs a certain level of working capital to operate the business from day one without injecting additional cash.
In most acquisitions, the purchase agreement defines a “target” working capital, typically based on an average of the company’s working capital over the preceding twelve months. If the actual working capital at closing exceeds the target, the seller gets the surplus. If it falls below the target, the seller owes the difference.
The adjustment usually happens in two steps, not one. A few days before closing, the seller delivers an estimated closing statement, and the price paid at closing is trued up against the target using that estimate. Then, 60 to 90 days after closing, the buyer prepares the final closing balance sheet, and the parties settle the difference between the estimate and the buyer’s final number, often out of an escrow set aside for that purpose. The letter that arrives sixty days later is this second step, the post-closing true-up, and it happens whether the deal closed the same day it was signed or ninety days afterward.
The concept is straightforward. The execution is where sellers get hurt.
How the Definition Gets Weaponized
Sophisticated buyers spend significant time negotiating the definition of working capital in the purchase agreement. Which line items are included? Which are excluded? How are receivables valued, at face value or net of a reserve for doubtful accounts? How is inventory counted, at cost or at the lower of cost or market? Is prepaid rent included? Are accrued bonuses included?
Every one of these decisions moves the number. A buyer who excludes cash from the definition and includes accrued liabilities has effectively shifted the target in their favor. Excluding cash from the definition is not itself the trick. Most deals are cash-free and debt-free, and cash and debt are handled separately in the price, so leaving cash out is standard. The advantage comes from asymmetry and mismatch: setting the target on one methodology while measuring the closing balance sheet on another or picking a target period that does not line up with where the company sits in its working capital cycle on the closing date. A seller who doesn’t understand how these definitions interact will agree to terms that look neutral on paper but produce a below-target result at closing almost every time.
I’ve seen purchase agreements where the working capital definition was drafted so that the target was virtually impossible to meet. The buyer didn’t do anything improper. But the seller’s attorney needs to push back on the definition or the seller will pay for it at closing.
The Measurement Date Problem
Working capital is measured as of the closing date, but the closing date balance sheet is typically prepared after closing by the buyer’s accountants. The seller usually has a 30-to-60 day window to review and object to the buyer’s calculation. But by then, the buyer controls the company’s books. The buyer decides how to classify items, what reserves to establish, and what adjustments to make.
This asymmetry is real. The seller is reviewing numbers prepared by the buyer, using the buyer’s accountants, applied to records the seller no longer controls. Disputes about the closing balance sheet are common, and they tend to favor whoever controls preparation of the closing balance sheet, which is the buyer, unless the seller has retained an accountant experienced in purchase-price disputes.
The Pre-Closing Cash Drain
Here’s a trap that catches unsophisticated sellers when there is a deferred closing. In the months before closing, you might accelerate collections to boost your cash position. You might delay paying vendors to preserve cash. You might pull forward revenue recognition. All of this feels like good business, but if it artificially inflates working capital above the target, the purchase agreement may require you to leave that excess in the business. And if the buyer’s accountants reverse those accelerations in the closing balance sheet, working capital drops, and you owe money back.
The smarter approach is to operate the business in the ordinary course during the pre-closing period, which is what the purchase agreement almost certainly requires anyway. Any deviation from ordinary course gives the buyer ammunition to challenge the closing working capital calculation.
Keep in mind this trap only applies when there is a gap between signing and closing. In a same-day sign-and-close there is no pre-closing period for you to operate through, so this trap falls away, though the post-closing true-up still applies.
How to Protect Yourself
Three things protect sellers in the working capital adjustment. First, negotiate the definition before you sign the letter of intent, not after. Once you’re in the purchase agreement stage, you’ve lost most of your bargaining power on economic terms. The definition of working capital, the target, and the methodology should be part of the LOI discussion.
Second, insist on a detailed schedule of included and excluded items attached to the purchase agreement. Vague definitions produce disputes. Specific schedules prevent them. If the buyer resists specificity, that should tell you something about their intentions.
Third, hire a transaction accountant with quality-of-earnings or purchase-price-dispute experience or accountant who has been through post-closing working capital disputes before. This is not general accounting work. It requires someone who understands how purchase agreements define working capital and how buyers’ accountants prepare closing balance sheets. The fee for that advisor will be a fraction of what a disputed adjustment costs.
Are You Prepared for What Happens After the Wire Hits Your Account?
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