In most M&A transactions, the purchase price is adjusted after closing based on the amount of working capital delivered at closing compared to a negotiated target. The idea is straightforward: the buyer expects the business to be delivered with a “normal” level of current assets necessary to pay current liabilities and operate the business in the ordinary course. If actual working capital at closing is higher or lower than that agreed target, the purchase price is typically increased or decreased dollar-for-dollar.
This “working capital adjustment” is supposed to be mechanical. By the time a transaction closes, the economics are set, the valuation is agreed, and the adjustment is framed as a true-up. Yet working capital adjustments remain one of the most common sources of post-closing disputes (comprising 50% or more of post-closing disputes according to various deal studies over recent years). While the concept appears straightforward, the application often is not. Imprecise contract language, ambiguous accounting references and misaligned expectations or disparate accounting practices between buyer and seller can turn a routine adjustment into an expensive post-closing fight. Understanding where these disputes arise, and how to best to mitigate the risk of them prior to signing, can materially reduce post-close friction.
“Consistent with past practice” is not as clear as it sounds.
Most purchase agreements require working capital components to be calculated in accordance with GAAP (subject to agreed exceptions), “consistently applied,” or “consistent with past practice.” While that language can feel protective, it often is not. Problems arise when a target company’s past practices were informal or undocumented, inconsistent over time, or changed as the company matured, in each case even while GAAP-compliant. The buyer and seller may also interpret “consistency” or apply GAAP differently.
Once the post-closing adjustment process begins, each side tends to apply the standard that favors its position. Ambiguous accounting standards invite interpretation and disputes.
Working capital “pegs” are often poorly set.
The working capital peg is meant to reflect a “normalized” level of working capital based on trending historical averages. Trailing 12-month working capital balances are commonly used as a starting data point. In practice, it’s often a negotiated number derived from incomplete data. Common issues include seasonal fluctuations that are not fully accounted for, one-time items that are embedded in the baseline, growth or contraction trends that are ignored and pre-closing operational changes that distorted the average.
When the working capital peg doesn’t reflect the business reality, it will materially affect the value of the transaction to the parties, rather than play a neutral role as intended. An improperly calibrated peg will turn the post-closing true-up into a renegotiation of purchase price .
Dispute resolution mechanisms lack specificity.
Most purchase agreements provide for a neutral accountant to resolve disputes. Only some specify how that process should work. Gaps may include the scope of the accountant’s authority, the standards of review, the ability to consider extrinsic evidence and timelines and cost allocation.
Without clarity, even the dispute resolution process becomes contested. An unclear resolution mechanism increases cost and delay regardless of who ultimately prevails.
Deal fatigue encourages late concessions.
The methodology for working capital adjustments and determination of the peg are often finalized late in the process, when deal fatigue is highest. This is when parties are more likely to accept vague definitions, defer open accounting questions, assume that good faith will prevail and that there is an unwritten “business agreement” on a particular term and underestimate the likelihood of a future dispute.
These concessions rarely affect closing, but frequently affect adjustment economics. Post-close disputes often trace back to late-stage compromises.
How to reduce the risk.
While no working capital adjustment mechanism is dispute-proof, buyers and sellers can meaningfully reduce risk by anchoring standards to specific accounting treatments where possible, stress-testing the working capital peg with modeling and scenario analyses, tightening dispute resolution mechanics and identifying adjustment terms as non-negotiables early in the process.
