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What is a working capital peg, and how does it affect the purchase price?

When two companies come together in a merger or acquisition, one of the key components of the deal is determining the purchase price. One aspect of the purchase price that is often subject to negotiation (and often contention) is the working capital peg. In this blog post, we'll explore what a working capital peg is, how it is calculated, and how it is secured after the acquisition.


What is a working capital peg?

Working capital is the difference between a company's current assets and current liabilities. It is a measure of a company's ability to pay its short-term obligations. In the context of an M&A transaction, the working capital peg is a mechanism used to ensure that the target company has sufficient working capital at the time of the acquisition.


How is the working capital peg calculated?

The working capital peg is typically calculated as a percentage of the target company's trailing twelve-month average working capital. This percentage can vary, but is usually in the range of 10-20%. The peg represents the amount of working capital that the target company is expected to have at the time of the acquisition.


If the target company's working capital at the time of the acquisition is less than the peg amount, the buyer will typically receive a price adjustment to compensate for the shortfall. Conversely, if the target company's working capital at the time of the acquisition is more than the peg amount, the buyer may receive a price adjustment to account for the excess.


How is the working capital peg secured after the acquisition?

After the acquisition is complete, the working capital peg is typically secured through a holdback or escrow arrangement. A holdback is a portion of the purchase price that is held in reserve by the buyer to cover any potential working capital shortfalls. An escrow is a separate account that holds a portion of the purchase price for a specified period of time, typically 12-24 months.


During this holdback or escrow period, the buyer may request that the target company provide regular updates on its working capital position. If the working capital falls below the peg amount during this period, the buyer may use the holdback or escrow funds to cover the shortfall. Conversely, if the working capital exceeds the peg amount, the excess funds will be released to the seller.


In conclusion, the working capital peg is an important component of an M&A transaction, as it ensures that the target company has sufficient working capital at the time of the acquisition. By understanding how the working capital peg is calculated and secured after the acquisition, both buyers and sellers can negotiate favorable terms that protect their interests and provide for a smooth transition. It is important to work with experienced M&A advisors and attorneys to ensure that the working capital peg and other purchase price adjustments are properly structured and documented. At Cross Key Partners, we have experienced the confusion sellers sometimes have around the working capital peg, and can help guide both you and them through the process to promote the most positive outcome and get a deal done.

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