Working Capital Pegs and Completion Accounts: Protecting Value at Closing

Working capital pegs and completion accounts are designed to deliver the business at closing with the agreed level of operating resources and debt. The peg represents normal working capital; completion accounts measure the actual position at closing under agreed rules. The difference adjusts the purchase price. Done well, the mechanism protects both buyer and seller. Done poorly, vague definitions turn routine accounting into a value dispute.

Why a working capital peg matters

Enterprise value is commonly negotiated on the assumption that the business is delivered cash-free, debt-free and with normal working capital. Without a peg, a seller could accelerate collections, delay supplier payments or reduce inventory before closing while still receiving the same enterprise value. The buyer would then fund the shortfall after closing.

A simplified, illustrative bridge is:

Equity purchase price = enterprise value − closing net debt ± working capital adjustment ± other agreed items

If actual qualifying working capital is above the peg, the price usually increases; if below, it usually decreases. The agreement, not convention, controls the result. Legal advisers should draft the mechanism and dispute process around the transaction's facts.

Define working capital before calculating it

Net working capital is often defined as specified current operating assets minus specified current operating liabilities. A transaction schedule should list included and excluded accounts, not rely on a generic balance-sheet label. Typical included items may be trade receivables, inventory, trade payables and operating accruals. Treatment of customer advances, indirect taxes, employee accruals, provisions, related-party balances and capital creditors must be explicit.

Three classification rules help:

1. Include balances required for ordinary operations.
2. Exclude cash, financing and items already captured as debt or debt-like.
3. Apply the same classification to the historical peg and closing amount.

Accounting policy matters too. Specify revenue cut-off, inventory costing and provisioning, bad-debt reserves, rebates, returns, foreign exchange, accruals and intercompany balances. Hierarchies such as specific transaction policies first, consistent past practice second and the applicable accounting framework third need careful drafting because the rules can conflict.

Set a normalised working capital peg

A trailing average is a starting point, not an answer. Build monthly working capital for enough history to identify seasonality, growth, price changes and unusual behaviour. Reconcile management data to financial statements and test whether month-end practices are representative.

Analyse each component in operational units:

• receivable days by customer and subsequent collection;
• inventory days by raw material, work in progress and finished goods;
• payable days by supplier and payment run;
• accrued expenses and rebates by underlying activity; and
• customer advances against order and delivery obligations.

Adjust the historical series only with evidence. A discontinued product, acquired division or lasting change in customer terms may justify normalisation. A hoped-for collection improvement does not. If the business is strongly seasonal, one annual average can misstate the amount required on the scheduled closing date. Consider a month-specific peg, seasonal corridor or other mechanism advised by the transaction team.

Growth also matters. Revenue may rise faster than the historical balance, requiring more receivables and inventory. Translate forecast sales and cost of sales into defensible days assumptions rather than scaling every account mechanically.

Prepare completion accounts that can be reproduced

The sale agreement should define the closing time, reporting perimeter, currency, accounting rules, form of statements, preparation responsibility, delivery timetable, access rights and objection process. A sample completion statement prepared before signing is valuable: it reveals ambiguous classifications while parties can still resolve them.

At closing, preserve evidence. Capture bank statements, receivable and payable ageing, inventory counts, goods in transit, dispatch and receipt cut-off, payroll accruals, tax ledgers and manual journals. Control post-close entries that relate to the pre-close period. Where estimates are unavoidable, document the basis and consistent application.

Completion accounts should be purpose-built for the contract, not mistaken for statutory financial statements. They may use transaction-specific definitions that differ from general-purpose reporting. Qualified accounting and legal advice is essential.

Watch for value leakage and manipulation

The period between signing and closing creates incentives and practical risks. Monitor ordinary-course covenants and agreed consent rights without taking premature control. Common warning signs include:

• collections accelerated through unusual discounts;
• suppliers paid later than normal;
• purchasing or maintenance deferred;
• obsolete inventory retained at full value;
• sales booked before control or acceptance requirements are met;
• accruals released without operational support; and
• transactions moved between related entities.

Test movements against prior months, budgets, source documents and cash after closing. A balance can be arithmetically correct yet economically abnormal.

Prevent double counting across the equity bridge

Every item should have one home. Overdue capital expenditure invoices may be treated as capital creditors, debt-like items or working-capital payables depending on agreed definitions—but not more than once. Customer advances may be ordinary working capital in one business and debt-like in another if they fund obligations that the buyer must fulfil without future cash.

Create a classification matrix covering the quality-of-earnings analysis, working-capital schedule, net debt schedule and specific indemnities. Reconcile it to the purchase agreement and funds flow. This is particularly important for leases, tax balances, provisions, bonuses, transaction costs and related-party accounts.

Use sensitivity analysis before agreeing the peg

Model the price effect of alternative periods, seasonal closing dates and disputed classifications. Show how inventory provisions, receivable collectability or supplier cut-off affect both the peg and actual completion amount. The objective is not to choose the most favourable number; it is to understand which assumptions can move value and settle them explicitly.

An illustrative example: if the agreed peg is ₹20 crore and qualifying closing working capital is ₹17 crore, the mechanism may reduce equity price by ₹3 crore, subject to the agreement. If the ₹17 crore was measured using a new inventory provision not reflected in the peg, the comparison may be inconsistent. The policy must be applied to both sides.

Conclusion

A working capital adjustment protects value only when it compares like with like. Define the accounts, establish normal operations from monthly evidence, anticipate seasonality and preserve closing records. Completion accounts then become a controlled measurement process—not a second negotiation after the business has changed hands.