You agree a sale price, shake hands on the big points, and start thinking about what comes next. Then the buyer’s team looks under the bonnet and spots a problem: there’s less stock than normal, more unpaid supplier bills, and not enough day-to-day cash tied up in the business to keep trading smoothly.
That’s when a working capital peg matters. It’s the rule that stops the purchase price being quietly reshaped by last-minute swings in stock, debtors, and creditor timing.
This guide is for UK founders and SME owners planning a sale, investment, or buyout. It explains what a peg is, how it’s set, what happens at completion, and how to avoid losing value through avoidable working capital issues.
What a working capital peg is, and why deals use it
A working capital peg is an agreed target level of working capital that the seller must leave in the business at completion. Think of it as the “normal operating level” the buyer expects to inherit so the company can keep trading on day one.
Working capital is usually:
Working Capital = Current assets minus current liabilities
In plain terms, it’s the short-term stuff that moves with trading. Common items include:
- Trade debtors (customers who owe you money)
- Stock (inventory held for sale or use)
- Prepayments (costs paid in advance)
- Trade creditors (supplier bills you owe)
- Accrued expenses (costs incurred but not yet invoiced or paid)
The purpose is simple: the buyer wants a business that can operate without an immediate cash injection, and the seller wants fewer arguments after signing. With a peg, both sides have a clear target rather than a vague feeling about what “normal” looks like.
A peg sits alongside the headline valuation. It’s usually linked to a completion accounts process (or another working capital adjustment mechanism) that checks what working capital actually was at completion and adjusts the final price up or down.
Working capital peg vs cash-free, debt-free, and normal working capital
Many UK private company deals are agreed on a cash-free, debt-free basis. That means:
- Cash is treated as an extra, if there’s more cash than assumed, the seller usually benefits.
- Debt is treated as a reduction, if there’s debt at completion, the seller usually bears it.
Working capital is different. The price assumes the company is delivered with a normal level of working capital. The peg defines what “normal” means and avoids a debate like, “you’ve left us a business that looks profitable but can’t pay its bills”.
This is where confusion often creeps in. A few items can sit in grey areas, and definitions decide who pays:
- Overdrafts: is it debt, or part of day-to-day working capital?
- VAT and PAYE balances: are they treated as normal trading liabilities, or debt-like items?
- Director loan accounts: are they repaid before completion, left in, or treated as debt?
None of these are “right” or “wrong” by default. What matters is that the sale agreement sets out clear definitions so the maths matches the deal intent.
What happens if actual working capital is above or below the peg
At completion (or shortly after, once completion accounts are prepared), actual working capital is compared to the peg.
- If actual working capital is below the peg, there’s a shortfall. The purchase price usually reduces pound-for-pound (or the seller funds the gap).
- If actual working capital is above the peg, there’s a surplus. The purchase price usually increases pound-for-pound (or the buyer pays the extra value).
A simple example with round numbers:
| Item | Peg (Target) | Actual at Completion | Difference |
|---|---|---|---|
| Working Capital | £500,000 | £420,000 | £80,000 shortfall |
If the adjustment is pound-for-pound, an £80,000 shortfall reduces what the seller receives by £80,000. In practice, it might be settled through a reduction in deferred consideration, a payment after completion, or another mechanism agreed in the contract.
Timing matters. Completion accounts are often finalised weeks or months after the deal closes. That can mean the seller only discovers the cash impact later, and may need to refund money when they least expect it. The buyer, on the other hand, may have to pay extra if working capital lands above the peg.
How a working capital peg is set in practice
Most pegs are set by looking at average working capital over a historic period, often the last 12 months (sometimes 6 to 18 months). The logic is that a full year captures the normal rhythm of trading.
The peg should reflect what the business needs to run day-to-day, not the number that suits one side. If it’s set too high, the seller risks a price hit even if the business is healthy. If it’s set too low, the buyer may inherit a business that needs an immediate cash top-up, and the deal can become tense fast.
In most transactions, the peg is negotiated during due diligence. The cleaner your data, the quicker it moves from argument to agreement. When monthly management accounts reconcile to the balance sheet, and debtor and stock reports make sense, the peg discussion becomes far less personal and far more factual.
Seasonality, growth, and one-off swings that can distort the peg
Averages sound fair until the business isn’t “average”. Many SMEs have working capital patterns that swing hard through the year.
Common examples:
Retail and e-commerce: Stock builds before peak season, then drops after. A peg based on the wrong month can be miles off.
Agencies and project firms: Work in progress and unbilled time can move sharply, especially when a large project starts or ends.
Subscription businesses: Annual billing can create large deferred income balances (and a cash boost) that changes what “normal” looks like.
Fast growth: Headcount rises, supplier spend rises, and debtor balances often rise with revenue. Last year’s average might not fund next quarter’s trading.
One-off shocks also distort working capital: a delayed customer payment, a supplier dispute, a temporary supply chain delay, or a big project with unusual terms. The aim is not to ignore reality, it’s to normalise what won’t repeat.
A practical tip: plot working capital by month (at least 12 points) and annotate the spikes. If you can explain the story in a few sentences, you can usually negotiate a fair adjustment. If you can’t explain it, the buyer will assume the worst and price in risk.
Items buyers and sellers often include or exclude (and why it matters)
The peg isn’t just a number, it’s a definition. Small wording changes in the SPA can move value by tens or hundreds of thousands.
Below are common items that cause disagreement, and the risk each creates.
Aged receivables (overdue debtors): Buyers may discount old debts or exclude them from working capital if collection is uncertain. Sellers may argue they’re still collectible. Agree the treatment and any ageing thresholds early.
Obsolete or slow-moving stock: Stock values can look strong on paper even when items won’t sell. Buyers often push for write-downs or exclusions for dead stock, consignment stock, or stock held for discontinued lines.
Related-party balances: Amounts due to or from directors, group companies, or connected parties can be treated as debt-like rather than normal trading balances. If they stay in, they can skew the peg and trigger disputes.
Unusual prepayments: A large annual insurance prepayment just before completion can inflate working capital. Buyers may want it normalised if it’s not part of typical run-rate.
Accrued bonuses and commissions: If a bonus scheme exists but accruals haven’t been recorded consistently, working capital can look better than it is. Buyers will usually want a consistent approach.
VAT and PAYE: These can be normal trading liabilities, but some deals treat them as debt-like items. The right answer depends on how cash, debt, and working capital are defined as a set.
Deferred income and customer deposits: If customers pay upfront, the liability reduces working capital. Some sellers forget this when discussing “cash in the bank”. Buyers care because they’ve acquired the obligation to deliver.
Provisions: Provisions for returns, claims, or dilapidations can be working capital items or treated as debt-like. The key is consistency with historical accounts and the deal structure.
The simplest rule is this: if both sides want the adjustment to reflect normal trading, the definition must be written clearly enough that two different finance teams would calculate it the same way.
Common working capital peg pitfalls for SMEs (and how to avoid surprises)
Working capital disputes rarely come from fraud or chaos. More often, they come from normal founder behaviour that makes sense operationally but looks odd in a deal process.
Buyers don’t just want a decent month-end snapshot. They want evidence the business produces cash in a steady way and that profits are backed by collectable invoices and saleable stock. That’s part of quality of earnings, and it’s also why working capital gets so much attention.
Here are common pitfalls that reduce proceeds or delay completion:
Chasing a headline number instead of the normal run-rate: A strong month can hide weak discipline in billing, stock controls, or supplier management.
Changing payment timing: Paying suppliers faster to look “tidy” can lift creditors down and reduce working capital. Stretching suppliers can do the opposite but may upset key relationships and still unwind after completion.
Ignoring cut-off and accruals: If expenses aren’t accrued consistently, working capital can be flattered at completion, then corrected in completion accounts.
Letting debtors drift: A growing debtor book feels normal in growth mode, but buyers will test it hard, especially ageing, disputes, and credit notes after period end.
Pre-completion behaviour that can trigger a working capital shortfall
The final weeks before completion can quietly change working capital, even if revenue looks fine.
Actions that often push working capital below the peg include:
- Running stock too low to release cash, which can risk service levels and future sales.
- Paying down creditors faster than normal to “clean up” the balance sheet.
- Offering heavy discounts or unusual terms to pull in cash, while weakening margins and creating returns risk.
- Pausing purchasing or delaying routine spend, which often rebounds immediately after completion.
- Delaying accruals (payroll, bonuses, professional fees), which makes completion working capital look better than it really is.
- Posting one-off credits or reclassifications that don’t reflect trading reality.
The problem is not that these actions are immoral. The problem is that they move the working capital number away from normal. If the deal assumes normal working capital and you deliver something else, the peg mechanism pulls value back.
How to prepare for a fair peg before you sell or raise investment
Preparation is less about fancy models and more about clean reporting and clear policies. If you can show a stable working capital story, negotiations become calmer and outcomes improve.
A simple checklist that works for most SMEs:
Clean aged debtors: Agree balances to statements, chase disputes, and separate slow payers from true bad debts.
Stock review and write-down policy: Document how you treat obsolete items, slow movers, and stock held for specific projects.
Consistent cut-off: Make sure invoices, credit notes, goods received, and accruals are posted in the right period, every month.
Monthly working capital schedule: Track debtors, stock, prepayments, creditors, accruals, and deferred income in one view, with short notes on major movements.
Documented accounting policies: If you capitalise certain costs, accrue commissions, or treat WIP in a specific way, write it down and apply it consistently.
It also helps to agree working capital definitions early in the process, not in the final week when everyone is tired. A dry-run peg calculation, based on the draft SPA definitions, often surfaces issues while you still have time to fix them.
Consult EFC can support this work by preparing the working capital schedule, stress-testing the definitions during diligence, and helping you defend a fair position in negotiation with evidence rather than opinion.
Conclusion
A working capital peg protects both sides, but only when the definition and the data are strong. If you understand what sits inside Working Capital, you can spot value leaks before they hit your sale proceeds. Set the peg based on normal trading, document inclusions and exclusions clearly, and avoid last-minute moves that distort the balance sheet. Your next step is simple: review the last 12 months of working capital trends, explain the spikes, and fix the weak spots before you start a transaction process.
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