redactedAdjusted EBITDA gets talked about and debated endlessly in broad daylight during negotiations. However, the working capital peg is often negotiated just as hard inside the deal and discussed far less outside it, and depending on how the deal is structured it can move the seller's proceeds just as far. Every dollar of working capital under the peg at true-up is a dollar the seller replenishes after the wire clears. Money already mentally accounted for, now moved back into the buyer's bank account. A six-figure adjustment is routine, and the litigated ones have run into the millions. Cash-Free, Debt-Free Interest and income taxes come out of earnings because they describe how the seller financed and structured the business, not how it operates. Depreciation and amortization come out for a cousin of that reason: they're non-cash charges tied to what the seller bought and when, on a basis the buyer won't inherit. Cash and debt come off the balance sheet on the same logic. They represent the seller's financing and investing decisions rather than the operation, and normalized working capital has to present only the operating components of the balance sheet the same way EBITDA presents the operating components of the income statement. On the balance sheet, the piece that survives is adjusted working capital. In a deal that means receivables, inventory and prepaids on one side, less payables, accrued payroll and benefits, earned time off, and customer deposits on the other. Those are operating components and the buyer needs enough of them on day one to keep the doors open. The entire reason there's a working capital target (peg) is to prevent the need for additional funding of working capital post close. Before anyone can negotiate the number, somebody has to build it. Plenty of businesses in the SMB and even some in the LMM space run their books on a cash or modified cash basis, and often those books have no or limited working capital to test. On a cash basis, the balance sheet has no receivables, no inventory, no payables and no accruals to begin with. That means the number needs to be constructed before it gets argued: receivables rebuilt from invoices and collections, payables from bills and payments, compensation and commissions accrued, deposits deferred, revenue cut off in the period it was earned instead of the period it was banked. That rebuild is called a cash-to-accrual conversion, which is how I end up in somebody's QuickBooks on a Saturday in October. Banks and larger players prefer to see the number on a GAAP basis, and that is why financial due diligence scopes and timelines start with the condition of the books rather than the quality of the earnings. Once it exists, the peg is usually an average of month-end balances, most often over the trailing twelve months, which smooths the busy and slow stretches. Twelve months isn't the only choice; reviews run trailing twelve, six and three months, and on a growing business the shorter window sets a higher peg, because working capital grows with revenue. Whoever is paying attention picks the window that helps them and waits to see whether anyone asks. So ask: which window, and why. On a seasonal business it isn't a subtle question. A company carrying $2.5M of working capital in season and $1.0M out of it can have its peg set hundreds of thousands of dollars wrong by a window that leans on the wrong months. Either way, the peg gets analyzed both as a nominal figure and as a percentage of revenue, though the deal itself is expressed on the nominal figure. redactedA reviewer tests the components, not just the total. Two sellers both present $900,000 of net working capital. One of them has $900,000 that's clean. The other's includes $150,000 of inventory that stopped moving in 2024 and $75,000 of receivables from customers who quit paying last spring. Both sit inside the stated $900,000. Adjusted, the second seller is delivering $675,000 against the same stated number, and the adjusted figure is the one the peg should be set against. redactedSo the work happens one component at a time. Receivables get tested against what it's reasonable to assume will actually be collected. Inventory is reviewed for obsolescence and for stock worth less than the books say. The accrual list gets built item by item: earned but unpaid time off, bonuses and commissions payable next year, warranty work owed on everything already sold, deposits sitting in a checking account and nowhere on the books. A mature company that has never recorded a bad-debt reserve or taken an inventory write-off isn't a company or a management team acting nefariously. They're simply running their business day to day and not focused on dialing a perfect working capital number every month. That is precisely why diligence exists. One test works from the other direction. Put revenue growth and working capital growth side by side for the trailing two years. If revenue is climbing while working capital stays flat, there are two honest explanations and both are findings. Either the growth is real and nobody is funding it, with receivables and inventory running lean until the day they can't, which becomes the buyer's cash problem in month one. Or the working capital is telling the truth and the revenue isn't, because real sales leave tracks: customers who owe money, and inventory or payroll to serve them. The debates get won in the definitions. Customer deposits or upfront payments are the first place the line gets tested. The buyer calls them debt-like: money collected for work somebody still has to perform, which is borrowing from the customer. The seller calls them ordinary working capital. Same dollar, and it either comes off the price or counts toward the peg. The operating-versus-financing test is what settles it in practice: whether the deposit is matched by work in process that conveys, or whether the buyer is inheriting the obligation with none of the funding. The collar is the next one. A collar is a no-adjustment band around the peg: land inside it and nothing happens, land outside it and the adjustment runs dollar for dollar. Whether a deal has one, and how wide it is, is the difference between a $60,000 miss costing the seller $60,000 and costing nothing at all. Plenty of lower-middle-market deals run with no collar and straight two-way settlement. Deal structure changes the mechanism, but not the exposure. In a stock deal the whole balance sheet transfers, so the peg and the post-close true-up are the machinery to settle during negotiations. True-ups typically happen 90 days post close. In an asset deal where the seller keeps specific agreed-upon components of the balance sheet, there is less of a peg to argue about; the buyer might only purchase receivables and inventory. The buyer still has to fund day-one working capital out of their own pocket, which on a financed deal means the lender wants twelve months of working capital adequacy analyzed before committing. Any customer deposits assumed with open jobs become credits against the price at closing, because the buyer is inheriting the obligation to finish work the seller was already paid for. SBA-financed deals carry a wrinkle that cuts against all of it. The working capital settlement often happens at close with no post-close true-up at all. That sounds like relief and it's the opposite: no true-up means no do-over, so the number has to be right before the closing. The advice is the balance-sheet version of Issue 2's recommendation. Know these numbers in and out before the other side does. Understand the components, how they fluctuate month-to-month depending on the season. The target should be calculated well before anyone sits across from a buyer, on a defined window, with the stale receivables, dead inventory and unrecorded liabilities already normalized out to get to the adjusted number. Then put the definition in the agreement: which accounts, which window, and what counts as debt-like. Working capital disputes are among the most common sources of post-close claims. Nearly all of them trace back to a definition nobody pinned down while everyone was still friendly. Coming up next: profit (EBITDA) versus cash. Why a P&L can look excellent while the bank account tells a different story, and how a buyer's review works out which one is lying. Ryan Anoskey, Partner, LIMESTONE.