So, your business sale is moving along smoothly. The number in the letter of intent (LOI) looks exactly like what you hoped for. You shake hands, the deal moves forward, and then a few weeks later, a working capital adjustment cuts your proceeds by hundreds of thousands of dollars.
Wait—what happened?
This scenario is more common than many business owners realize. In many cases, the problem isn’t the adjustment itself. It’s that the seller didn’t fully understand how working capital factors into the transaction.
Working capital is one of the most negotiated—and often misunderstood—parts of a business sale. How it’s defined, calculated, and handled at closing can have a significant impact on the final amount you ultimately walk away with.
At CTA Business Brokers, we address working capital with sellers early in the process. The reason is simple: surprises at closing are rarely small, and understanding the issue upfront gives you a much clearer picture of what your deal is really worth.
First, Let’s Define Working Capital
Working capital is the difference between a business’s current assets and current liabilities. In practical terms, it’s the financial fuel that keeps a business running day to day. It’s what helps the company pay vendors, cover payroll between customer payments, maintain inventory, and handle its normal operating obligations.
The basic formula is:
Working Capital = Current Assets − Current Liabilities
Current assets may include accounts receivable, inventory, and certain other assets expected to be converted to cash or used within the normal operating cycle. Current liabilities may include accounts payable, accrued expenses, and other short-term obligations. The resulting figure provides a snapshot of the financial resources available to support the business’s ongoing operations.
When you’re selling a business, the issue becomes more complicated. The question isn’t simply, “How much working capital does the business have?” The real questions are: How much working capital is expected to remain in the business at closing? What stays with the seller? What transfers to the buyer? And how is the final amount determined?
Those details can make a substantial difference in your final proceeds, which is why working capital should be addressed well before you get to the closing table.
What Happens to Each Component When You Sell a Business?
Not every component of working capital is treated the same way in a business sale. What happens to each one depends on the transaction structure, the terms negotiated between the buyer and seller, and what the business needs to continue operating after closing.
Here’s how the major components are typically handled.
Cash
In most business sales, cash stays with the seller. This is one of the more common conventions in private business transactions.
When a buyer purchases your business, they’re generally buying the operating business—the assets, customer relationships, employees, equipment, and systems that generate revenue. They’re not necessarily buying the cash the business has accumulated unless the purchase agreement specifically says otherwise.
There can be exceptions. A buyer may negotiate for some cash to remain in the business if they believe it’s necessary to fund operations immediately after closing. But in many transactions, cash is removed from the business before closing and retained by the seller.
If your business has a substantial cash balance, don’t assume it will automatically be yours or the buyer’s. Your business broker should address how cash will be treated as part of the deal structure and purchase agreement.
Accounts Receivable
Accounts receivable represents money customers owe your business for products or services that have already been delivered. How those receivables are handled depends heavily on the structure of the transaction.
In a typical asset sale, accounts receivable are often retained by the seller. The logic is straightforward: if you performed the work or delivered the goods before closing, the resulting receivable generally belongs to you.
That doesn’t mean buyers will ignore your accounts receivable. If they’re substantial, a buyer will likely want to examine their age, collection history, and overall quality during due diligence. Older or difficult-to-collect receivables can become a negotiating point, particularly if they raise concerns about the financial health of the business.
A stock or membership-interest sale is different. When a buyer acquires the legal entity itself—such as the stock of a corporation or membership interests in an LLC—the accounts receivable remain assets of that entity and generally transfer with it. This means it will go to the buyer.
That’s one reason transaction structure matters so much. Two businesses with the same purchase price can have very different outcomes for the seller depending on whether the deal is structured as an asset sale or an equity sale.
Inventory
Inventory is often where working capital discussions become more detailed—and more heavily negotiated. In many asset sales, inventory is included in the transaction because the buyer needs enough products, materials, or supplies to keep the business operating after taking over.
But that raises three important questions: How much inventory should be included? At what value? And what condition is it in?
Buyers typically want a normal level of inventory—the amount reasonably necessary to operate the business as it has historically operated. They generally don’t want to pay extra for inventory that was stockpiled simply to inflate the value of the business before closing.
That means a seller who significantly increases inventory in the months leading up to a sale could face questions from the buyer. The buyer may request an adjustment to the purchase price or negotiate a separate inventory count and valuation at or immediately before closing.
The condition of the inventory matters, too. Obsolete, damaged, or slow-moving products may not be worth their full book value to a buyer. During due diligence, buyers will likely look at inventory turnover and aging to determine how much of the inventory is actually saleable.
For that reason, the final inventory amount is often established through a physical count shortly before closing. The agreed-upon valuation method can then be applied to determine what, if anything, gets added to or deducted from the purchase price.
Accounts Payable
Accounts payable represents amounts your business owes to vendors, suppliers, and other creditors. Like the other components of working capital, its treatment depends on the transaction structure and the terms of the purchase agreement.
In a typical asset sale, the buyer generally does not assume the seller’s existing accounts payable unless the agreement specifically provides for it. Those obligations were incurred by the seller’s business before closing, so the seller may remain responsible for paying them.
That doesn’t mean accounts payable won’t affect the transaction. Buyers will examine outstanding vendor obligations during due diligence, particularly if the business has a history of paying bills late or has accumulated a significant backlog.
Sellers are generally expected to deliver the business with accounts payable at a normal or agreed-upon level. A large amount of overdue payables can raise questions about the company’s financial condition and may lead to negotiations over the working capital target or other adjustments to the deal.
The key takeaway is that working capital isn’t simply a number on a financial statement. Each component can affect what the buyer receives, what the seller keeps, and ultimately how much money the seller walks away with at closing.
The Working Capital Target: Why It Matters More Than Most Sellers Realize
This is where a business sale can get technical—and where sellers without experienced guidance can leave significant money on the table or face an unwelcome surprise at closing.
When a buyer acquires an operating business, they generally expect to receive a business that can continue operating as it has historically. That means having enough working capital to pay vendors, cover normal operating expenses, manage inventory, and keep the business running without requiring the buyer to immediately inject additional cash.
Many business purchase agreements establish what’s known as a working capital target, sometimes called a working capital peg. This is the agreed-upon level of working capital the seller is expected to deliver at closing.
The target is often based on the business’s historical working capital, such as a trailing 12-month average, although the methodology can vary depending on the business and the transaction. The idea is to establish a “normal” level of working capital that allows the buyer to take over the business without receiving substantially more—or less—working capital than the business typically needs.
If the actual working capital delivered at closing differs from the agreed-upon target, the purchase price may be adjusted accordingly.
Here’s an Example…
Suppose you agree to sell your business for $3 million, with a working capital target of $500,000. If the business has $620,000 of working capital at closing, that’s $120,000 above the agreed-upon target. Assuming the purchase agreement provides for a dollar-for-dollar adjustment, the seller could receive an additional $120,000, bringing the total purchase price to $3.12 million.
Now reverse the situation.
If working capital comes in at $380,000, that’s $120,000 below the target. Under the same adjustment mechanism, the purchase price could be reduced by $120,000, leaving the seller with $2.88 million.
That’s a $240,000 difference in proceeds between the two scenarios—even though the headline purchase price was $3 million in both cases.
That’s why the working capital provision deserves just as much attention as the purchase price itself.
Why Sellers Get Caught Off Guard
Most business owners are operators, not M&A (mergers & acquisitions) professionals. You’ve spent years focused on growing revenue, serving customers, managing employees, and keeping the business profitable. You probably haven’t spent much time studying the mechanics of working capital adjustments—and there’s no reason you should have to.
The problem is that sellers often encounter these details for the first time after the deal is already well underway. Here are a few common situations that can create an unexpected adjustment:
- Receivables are lower than normal. A seasonal slowdown, delayed billing, or an unusual change in customer payment patterns can reduce accounts receivable at closing and potentially push working capital below the target.
- Inventory is lower than expected. A seller may intentionally reduce inventory before a sale to free up cash. But if inventory falls below the level the business normally carries, the buyer may argue that the business isn’t being delivered with its expected level of working capital.
- Accounts payable are higher than usual. Delaying vendor payments may improve short-term cash flow, but it also increases accounts payable. Because accounts payable reduce working capital, an unusually high balance can contribute to a downward purchase-price adjustment.
- The target itself isn’t realistic. This may be the biggest issue of all. If a seller agrees to a working capital target without understanding how it was calculated, they could agree to deliver more working capital than the business historically requires. The result can be a shortfall—and a purchase-price reduction that was effectively built into the deal from the beginning.
This is why the working capital section of a purchase agreement deserves the same level of attention as the purchase price.
How Sellers Can Protect Their Interests
There are several practical steps sellers can take to better manage working capital throughout the sale process.
Understand Your Baseline Before Going to Market: Start by understanding what “normal” working capital looks like for your business. Review your historical working capital over the past one to two years and look for patterns.
If your business is seasonal, timing becomes particularly important. A company may have dramatically different working capital needs in January than it does in July. Knowing those patterns before negotiations begin gives you a much stronger position when a buyer proposes a working capital target.
Keep Operations Consistent During the Sale Process: Once your business is on the market, avoid making unusual financial decisions simply to make the balance sheet look better at closing. That includes unnecessarily stocking up on inventory, delaying vendor payments, or aggressively accelerating collections.
Buyers and their advisors will examine working capital trends, and unusual fluctuations can lead to additional scrutiny or questions during due diligence. The goal isn’t to manipulate working capital. It’s to operate the business normally and consistently.
Negotiate the Target—Not Just the Purchase Price: Sellers naturally focus on the headline purchase price. But the working capital target can have a meaningful impact on what you actually receive. The target is a negotiated number, and its calculation deserves careful review.
An experienced business broker and transaction attorney can help you understand the buyer’s methodology, evaluate the historical data, and negotiate a target that reflects the way your business actually operates.
Understand What Is Included—and What Is Excluded: Not every balance-sheet item automatically belongs in the working capital calculation. Cash is commonly excluded from working capital for transaction purposes, while certain debt-like or other specified items may also be excluded or treated separately.
The exact definitions depend on the purchase agreement. This is an area where seemingly small wording differences can have a significant financial impact. Don’t focus only on the target number. Make sure you understand exactly what goes into the calculation to arrive at that number.
Plan for the True-Up: The working capital calculation may not end when the transaction closes. Depending on the purchase agreement, the buyer may prepare a post-closing calculation comparing the working capital delivered at closing with the agreed-upon target. This can result in an additional payment or adjustment if the final numbers differ from the preliminary calculation.
That makes accurate books and thorough documentation especially important. If the buyer and seller disagree about the calculation, having clear financial records and a well-defined purchase agreement puts you in a much stronger position to resolve the issue.
Work With a Team That Understands the Nitty-Gritty of Working Capital
Working capital may sound like an accounting detail, but in a business sale, it can have a very real impact on your proceeds.
CTA Business Brokers has guided Washington business owners through hundreds of business sale transactions. Our business sale consultants understand where unexpected issues tend to arise, including the working capital concerns that can affect the final economics of a deal.
When we work with sellers, we don’t wait until the buyer’s attorney introduces a working capital provision in the purchase agreement. We help clients understand their historical working capital, identify the factors that influence it, and establish realistic expectations about what a buyer will likely require.
Most importantly, we help sellers approach the negotiation with a clear understanding of what they’re actually agreeing to deliver at closing. A $3 million offer, after all, isn’t necessarily a $3 million outcome if the deal structure includes an unfavorable working capital adjustment.
If you’re considering selling your business, a confidential conversation with us early in the process can help you understand what to expect before you sit across the table from a buyer.
Contact CTA Business Brokers today to speak with a business sale consultant about what your business may be worth, how working capital could affect your proceeds, and what you can do to maximize the value of your business when you’re ready to exit.