Sam thought the deal price was locked. Then the buyer cut the payout on completion day, citing a working capital shortfall he had never spotted.
Working capital is the money a business needs to keep the lights on. Think cash, stock, and invoices due, minus current bills and other short-term debts. If that pot is thin on completion, the buyer often pays less.
Term sheets set the early terms of the deal. They include how working capital will be measured, and what a “normal” level looks like. SPAs are the final sale contracts, where definitions and mechanics turn into binding numbers.
Here is the trap. If you accept a vague definition, or a benchmark that does not match how your business runs, the buyer can argue for a price cut. Seasonality, one-off orders, or COVID-era swings can all skew the number if you do not frame it right.
This post lays out what to watch and what to fix before you sign. You will learn the key definitions, the common adjustments, and how to set a fair target that protects your price. You will also see simple checks to run with your finance lead so there are no surprises at completion.
Get this right, and your headline price stays intact. Get it wrong, and the gap can be six figures or more. Let’s keep your hard-won value in your pocket, not lost in small print.
What Is Working Capital and Why Does It Matter in Business Sales?
Working capital shows if your business can meet today’s bills with today’s resources. Buyers use it to judge deal risk and to set price adjustments. If the figure is weak at completion, the buyer usually reduces the cash you receive. If it is healthy and stable, you protect your headline price.
How to Calculate Working Capital for Your Business
Start with current assets. Include cash that is free to use, customer invoices due within 12 months, and inventory that you can sell within the normal cycle. Add other short-term items like prepaid costs and deposits receivable. Then list current liabilities. Include accounts payable, VAT or other tax due, payroll accruals, and any short-term loans or overdrafts due within 12 months. Subtract liabilities from assets to get working capital.
Here is a simple example. Current assets of £50,000 minus current liabilities of £30,000 equals £20,000 working capital. That £20,000 is the buffer that keeps operations moving without extra cash.
Build the figure from clean month-end balances, not a rough mid-month snapshot. Use your trial balance and age your receivables and payables. Exclude obsolete stock and doubtful debts, or adjust them to net realisable value. Keep a record of any one-off items, such as a large prepayment or a supplier rebate, so you can explain them later.
Use your cloud accounting system for speed and consistency. Xero, QuickBooks and Sage produce the base reports, but do not rely on default classifications. Map each account to current or non-current with care. For accuracy, ask your finance manager or an external accountant to review the schedule and the policy choices behind it.
Seasonal swings can hide the true picture. A retailer in December shows a very different balance to April. Run a 12-month view and calculate the average working capital, then compare it to the month you plan to complete. This helps you set a fair target in the term sheet, so you are not caught out by timing.
Why this matters for sale prep is simple. Buyers will agree a working capital target and compare it to the actual figure at completion. If you present a clear, well-supported calculation and a sensible seasonal view, you reduce debate and protect value.
Signs Your Working Capital Could Hurt Your Deal
Several red flags warn of a price squeeze at completion. Tackle them early and you keep control of the narrative.
- Negative working capital: A distributor funds growth by stretching suppliers to 75 days while customers pay in 60. The gap flips the figure negative. In a sale, the buyer increases the working capital target or reduces the cash price to fill the hole on day one.
- Slow-paying customers: A services firm shows receivables aged over 90 days that keep rolling. The buyer marks down doubtful amounts and raises bad debt reserves. The completion statement then shows less working capital, which cuts the seller’s proceeds.
- High supplier debts: A manufacturer piles up payables to offset a stock build. The buyer assumes those bills must be cleared soon after completion. They adjust the price or demand a higher target to avoid funding your backlog.
- Bloated or obsolete stock: A wholesaler lists old lines at full cost, but they will only sell at a heavy discount. The buyer writes stock down to realisable value. The lower value reduces working capital and triggers a price adjustment.
- Short-term loan reliance: An overdraft props up day-to-day trading. The buyer either insists on repaying it before completion or treats it as a debt-like item. Either way, the net cash you receive falls.
- One-off timing boosts: A prepayment or a large once-a-year rebate makes one month look strong. The buyer normalises it across the year. If the completion month is artificially high, your proceeds shrink when it is adjusted.
These issues do not have to kill a deal. Pull forward collections, offer early payment discounts, and chase aged debts weekly. Clean your stock, write down slow movers, and set clear replenishment rules. Agree realistic supplier terms and stick to them. Replace short-term funding with longer-term facilities where possible. Document every judgment in a simple working capital paper. When buyers see order, they trust the numbers and keep the price.
Working Capital Clauses in Term Sheets: Key Terms to Watch
Working capital clauses shape how much cash you take home. The wording sets the benchmark at closing, the reconciliation after closing, and the path for any disputes. Keep the definition tight, the target fair, and the process clear. Small gaps here can wipe out months of profit.
Understanding Target Working Capital and Adjustments
The target working capital is the benchmark the business should hold at closing. It reflects a normal level for your cycle, not a best or worst month. Buyers compare the actual figure on the completion statement with this target.
Most deals use a true-up. After closing, the parties reconcile actual working capital against the target. If actual is below target, the seller pays the shortfall. If it is above, the buyer pays the excess.
- Example: target is £100,000 and actual is £80,000. The seller pays £20,000 back.
- The review window is usually 60 to 90 days post-close. The buyer prepares the completion accounts, then both parties agree the final adjustment.
The term sheet should nail down the definition and accounting policies. State what sits in working capital and what does not. Common practice excludes cash, debt, and debt-like items. Set treatment for obsolete stock, doubtful debts, rebates, and prepayments. Fix supplier terms and cut-off rules for shipments and returns. Lock the policies to the seller’s historic GAAP approach so there is no midstream change.
Pick a realistic target, not a convenient one. Analyse at least 12 months of month-end balances, with seasonality and any one-offs flagged. Strip out COVID-era distortions or one-time orders if they are not part of steady trade. Sense check with a normal trading month near the expected completion date. This prep prevents late pushback and protects your price.
Document the true-up mechanics in plain steps. Who prepares, who reviews, what evidence is needed, and the timetable for comments. Add a quick dispute path, often a named independent accountant, with costs shared or loser pays. Clarity speeds agreement and keeps the focus on trading, not wrangling.
Common Negotiation Tips for Term Sheet Working Capital
A few targeted asks can remove most of the downside. Use these to defend your exit price.
- Use a 12‑month average for the target: Smooths seasonality and avoids picking a weak month. This keeps the benchmark tied to how the business actually runs.
- Set caps on adjustments: A percentage cap, or a fixed pound cap, limits tail risk from late reclassifications or aggressive write-downs.
- Define what is excluded: Carve out cash, tax balances, deferred revenue that is not a short-term obligation, and any debt-like items. Less grey area means fewer deductions.
- Lock accounting policies: Reference the seller’s historic policies used in management accounts. Stops changes that would shrink receivables or raise reserves after signing.
- Agree inventory and debtor tests: Specify ageing thresholds, write-down rates for slow stock, and bad debt reserves. Predictability here shields the completion figure.
- Add a materiality threshold: Ignore tiny variances below a set amount. It prevents price erosion through a stack of minor adjustments.
- Include a floor and ceiling: Create a range around the target where no adjustment applies. Small timing swings then do not hit the price.
- Timebox the process: Fix dates for draft accounts, review, and final determination within 60 to 90 days. Certainty reduces noise and refocuses both sides on integration.
- Involve your advisor early: Your finance lead or deal advisor can model targets and test sensitivities. Early modelling spots weak points before they are in black and white.
- Require transparency on post-close actions: Bar policy changes and unusual collections or payments that would skew the true-up. Fair play keeps cash where it belongs.
Each point narrows scope for dispute and sets clear rails for the calculation. That clarity turns working capital from a moving target into a fair checkpoint, which keeps your headline price intact.
How Working Capital in SPAs Impacts Your Final Exit Price
Working capital in the SPA sets how much cash leaves or enters your pocket at completion and after. It anchors the price you actually receive, not just the headline number. The target you agree, the true-up rules, and any escrow can add or shave six figures from your payout. Get the mechanics clear, match them to how your business trades, and set timelines that protect you.
The True-Up Mechanism and Escrow in SPAs
A true-up is the final check on working capital at closing or shortly after. You agree a target working capital in the SPA. The buyer prepares completion accounts, compares actual working capital to the target, and then adjusts the price. If actual is below target, you pay the shortfall. If it is above, you get more.
An escrow is a separate account that holds part of the price for a set time. It covers working capital shortfalls, disputes, or small claims. It protects the buyer, but it ties up your money until release.
Here is a simple example that shows the moving parts:
- Headline price is £10 million. The SPA sets a target working capital of £1 million.
- At closing, 5 percent of the price (that is £500,000) goes to escrow.
- Post-close, actual working capital is £900,000, which is 10 percent below target.
- The £100,000 shortfall is taken from escrow first. The remaining £400,000 in escrow is released on schedule if there are no other claims.
Pros and cons to weigh:
- Buyer protection: escrow gives comfort that shortfalls will be covered without a chase.
- Seller cost: cash is trapped, you lose use of funds, and it can delay your plans.
Negotiate guardrails so cash does not sit idle:
- Staged releases: for example, one third at 45 days, one third at 90 days, balance at 180 days, assuming no open claims.
- Narrow scope: limit escrow use to named items, such as working capital, not general risks.
- Materiality thresholds: ignore tiny differences that would chip away at your payout.
- Policy lock: fix accounting policies to your historic approach, so reserves or write-downs do not expand post-close.
Keep the timetable tight. Aim for draft completion accounts within 30 to 45 days, comments within 15 days, and final determination by an independent accountant if needed. Certainty on timing lowers friction and speeds cash back to you.
Real Examples of Working Capital Affecting Exit Payouts
Short stories make the risk clear. These are anonymised, but common.
- Excess stock costs 10 percent of price
A consumer goods seller entered talks after a big pre-Christmas build. Inventory sat 20 percent higher than the 12‑month average, and a chunk was slow moving. The SPA required stock to be valued at net realisable value, not full cost. The buyer wrote down aged lines and lifted the target to reflect the higher inventory base. The combined impact cut the price by about 10 percent.
What went wrong: timing and weak stock hygiene. The team did not clear slow movers or reset buying after peak.
What to do instead: clean the catalogue early, tighten reorder rules, write down old lines, and target a completion date when inventory sits near the long-run average.
- Strong receivables add value
A B2B services firm improved collections six months before marketing the business. Days sales outstanding fell from 72 to 48, with tight credit checks and weekly calls. Bad debt reserves dropped on the back of cleaner ledgers, and the last three months showed steady cash conversion. The buyer accepted a higher working capital target and paid for the quality. The true-up then released a small surplus to the seller post-close.
What went right: clear policies, real discipline, and evidence across several months.
What to copy: age your debtors weekly, set firm credit limits, and match billing to delivery. Document the policy and show the trend line in your data room.
Practical lessons to bank before you sign:
- Pick your moment: complete after peak sell-through, not after a build. You want stock and debtors near normal, not inflated.
- Prove stability: show 12 months of balanced working capital, plus a simple bridge for one-offs.
- Tidy the edges: write down obsolete stock, collect old debts, and settle unusual payables. Small fixes now beat big debates later.
- Model the true-up: run sensitivities at plus or minus 10 percent of the target. Know the cash swing so there are no surprises.
Work these steps into your SPA planning. You protect your exit price, speed the true-up, and keep more of the money you earned.
Conclusion
Working capital sets how much of your headline price you keep. Know what sits in, set fair policies, and present clean data that reflects normal trade. Lock clear definitions and a sensible target in the term sheet, then keep the SPA mechanics tight, with a simple true up and firm timelines. That is how you avoid last minute cuts and protect the value you earned.
Take one practical step today. Audit your working capital with month end data, test it over 12 months, and note any one offs. Tidy debtors, write down slow stock, and document policies you already follow. Small moves now save big money at completion.
Do not leave this to chance. Ask your finance lead and a deal advisor to review your target, definitions, and true up path before you sign. They will spot weak points, model the cash swing, and give you a clean plan for completion.
Bring it back to the story that opened this post. Sam’s payout slipped because the rules were loose. Yours does not have to. Prepare now, write it down, and keep your exit price where it belongs, in your pocket.
