Working capital pegs do not grab headlines in a sale process, but they are often the number that decides whether a deal feels fair on day one. Get the peg wrong, and the buyer inherits a cash crunch or overpays for stock that will not turn. Get it right, and the handover runs smoothly with no last‑minute finger pointing.
I have sat in more completion meetings than I can count, from cafe chains in Shoreditch to HVAC contractors in London, Ontario. The cleanest closings share one trait. Both sides agreed early on what “normal” working capital looked like for that specific business, in that season, with that customer mix. Everything else, price, warranties, earn‑outs, hangs better when that definition is settled.
What a working capital peg actually is
In a typical cash‑free, debt‑free purchase, the buyer expects to receive a business with enough net working capital to run as it normally does. Net working capital, simplified, is current assets minus current liabilities, often restricted to items that turn within twelve months and that are essential to operations. For most deals, that means trade debtors, inventory, and prepayments on the asset side, and trade creditors, accruals, deferred revenue, and taxes payable on the liability side. Cash is normally excluded. Debt and debt‑like items are excluded and adjusted to price.
The peg is the agreed target for that net number at completion. If actual working capital delivered at completion is above the peg, the buyer typically pays the surplus pound for pound. If it is below, the purchase price is reduced accordingly. Sometimes the adjustment posts to a completion account 60 to 90 days later, after final numbers are prepared. Sometimes it is a locked box deal with no post‑completion adjustment, but even then the box date balance functions as a peg.
Why this matters in London
London is a specialist market layered over a general one. In the UK, you will see seasonality from tourism and weather, short lease cycles that demand chunky rent deposits, and VAT timing that can swing working capital by six figures in service businesses. In London, Ontario, a contractor may carry significant receivables from municipal or provincial jobs, and winter seasonality can park inventory on shelves for months. If you are searching through companies for sale London or have an off market business for sale introduced by a friend, the headline EBITDA says less about your first three months than the pattern of payables, receivables, and stock turns.
I once reviewed a Soho e‑commerce brand that looked beautiful on trailing earnings. The peg, calculated as a simple 12‑month average, ignored a planned shift to sea freight that stretched inventory days from 65 to 95. The buyer would have funded an extra 400,000 pounds of stock within 90 days post‑close. We fixed it by rebuilding the peg on a pro forma basis that reflected the new transport mode. Price did not change. Terms did. That saved a lot of late‑night calls.
Start with a clean definition
Before you square up on a number, lock down definitions. Most arguments come from scope rather than math. To avoid that, be explicit about:
- What is included and excluded from net working capital for this deal. The specific accounting policies used to measure each line item, especially inventory valuation and revenue recognition.
That is the first of the two short lists you will see in this piece. Everything else I will keep in prose, because the detail matters.
If the target runs inventory at cost but quietly writes down obsolete items once a year, you need that policy written into the SPA. If the target sells annual service contracts and books revenue straight‑line, ensure deferred revenue sits as a liability in the peg set. If they recognise revenue on delivery and you plan to change that policy, you should not expect the seller to fund that change through a lower peg. Aligned policy, then math.
Methods to set the peg
There are three patterns I see most often.
First, a trailing average. You take twelve months, sometimes six or eighteen, and calculate the average working capital using the agreed definition. You can do this monthly or at least quarterly. A simple average is common, though some deals weight recent months more heavily if the business is growing.
Second, a seasonal peg. For targets with strong seasonality, you do not want to penalise or reward the seller based on the date you sign. A garden center in Richmond will show bloated inventory in late winter and leaner shelves by August. For these, you pin the peg to the same month last year, or an average of the same quarter in the prior two or three years, adjusted for growth.
Third, a forward‑looking peg when the business is changing, for instance a supplier switch that alters lead times, a price rise that fattens receivables, or a shift in payment terms with key customers. You can build a pro forma peg by taking historical volumes and applying the new assumptions. This is more work, but it avoids silly disputes later.
For small businesses, keep it simple enough to explain in one breath. I once bought a plumbing supply distributor in Greater London with 6 million pounds of annual revenue. We set the peg using a rolling six‑month average because the inventory turns were stable, and we had a one‑off Brexit‑related stock build the prior year. The seller understood it. We all slept.
Completion accounts or locked box
Completion accounts deals measure the actual working capital at completion and make a post‑close adjustment. These fit businesses with volatile working capital or limited trust in month‑end accuracy. You do pay for complexity, since you will prepare a set of completion accounts and let advisors argue about accruals for six weeks.
Locked box deals fix the economic position at a past date, the box date. The seller warrants that no value leaks out, beyond agreed permitted leakages like salaries and usual dividends. Prices are set off that position, which makes for a cleaner close. If the target’s financials are robust, and the business is steady, a locked box can reduce friction. For London SMEs with uneven record‑keeping, completion accounts protect both sides.
In either case, you still need a peg or its locked box equivalent. If you are buying through a business broker London Ontario network or evaluating a business for sale in London presented by a boutique like liquid sunset business brokers or sunset business brokers, ask early whether the seller prefers completion accounts or locked box. That preference hints at their confidence in the numbers.
Debt‑like items that sneak into the peg
Buyers often get stung because an item that looks like working capital behaves like debt. You should pull debt‑like items out of working capital and treat them as price adjustments. Classic offenders include:
- Customer deposits for work not yet performed, when the costs to deliver sit in the future, not in current assets.
That is the second and final list. The reason is practical. Imagine you complete a build‑out project where the client paid a 30 percent deposit six months ago. You inherit a liability to deliver, but you did not receive the cash because cash is excluded. If you let that deposit sit inside working capital, you lose twice. Pull it out, reduce the price, then evaluate the peg on a clean basis.
Other tricky items: accrued bonuses and commissions, payroll tax liabilities, unpaid VAT, and unpaid holiday pay. In the UK, VAT timing can swing a month’s cash by hundreds of thousands. In Ontario, HST works similarly. If a completion date falls just before a VAT return is due, expect material liabilities that belong outside the peg.
Inventory: valuation is destiny
For product businesses, inventory is where pegs live or die. Three issues repeat across deals.
First, valuation method. If the seller runs average cost and you plan to move to FIFO, reconcile that delta so no one claims a surprise. If they include inbound freight and duty in cost, but you plan to capitalise differently, write it down in the SPA schedules. In London, importers from the EU altered freight assumptions after 2020, so historical numbers may not prove the point.
Second, obsolescence. Carve a policy into the agreement. For example, items with no movement for 12 months are valued at 50 percent, and items with no movement for 24 months are valued at zero. Then walk the warehouse and tag a sample. If you are scanning businesses for sale in London Ontario that carry long‑tail parts for agricultural equipment, expect slower turns and plan the peg around them.
Third, consigned stock and returns. If some stock in the warehouse is owned by suppliers or sits on consignment at customer sites, map it and exclude or adjust. Make sure your counting method at completion will capture reality, not hope.
Receivables and payables: a story in days
Do not accept aging summaries at face value. You need a narrative. Are late payers late every month, or did one large customer miss a cycle? Do payables show a silent financing line where suppliers hold 90‑day terms that will shrink to 45 days under new ownership? If you buy a small business for sale London where the founder has personal relationships keeping terms long, factor in that goodwill risk.
Receivables quality raises known traps in London service firms. Public sector clients pay slowly but surely. Private developers pay fast until they do not. In London, Ontario, government contracts can pay net 45 to net 90, and general contractors may hold back 10 percent retainage for months. If retainage sits in receivables, treat it carefully in the peg, perhaps with a haircut or an exclusion, then adjust price if needed.
On the payables side, scan for aged accruals that have become permanent fixtures rather than real liabilities. Old audit fees that were never reversed, provisions for litigation that settled two years ago, lease incentives amortised on a schedule that does not match the lease. Clean them out in diligence before they anchor the peg to fiction.
Seasonality and short closings
Short exclusivity windows invite sloppy pegs. I prefer at least two full monthly closes during exclusivity, which lets you see end‑to‑end cycles in receipts and payments. When you cannot, you need to engineer protection. For a garden design firm https://files.fm/u/t2c65dzb9y in North London, we closed in late February on a completion accounts basis with a temporary peg set to the prior February, plus a covenant that any extraordinary prepayments for spring shows would be treated outside working capital. We documented those outflows line by line. By May, the adjustment smoothed out and everyone was fine. If we had used a rolling twelve‑month average with no carve‑outs, the buyer would have paid for a seasonal bulge that delivered no benefit.
For buyers of small service businesses where the owner books revenue informally, build the peg from bank data and supplier statements, not internal ledgers alone. In one acquisition of a HVAC contractor listed under businesses for sale London Ontario, the QuickBooks aging looked healthy. Supplier statements told a different story, with 45‑day terms quietly extending to 100‑plus days in the weeks before LOI. The peg would have been too low by roughly 140,000 Canadian dollars if we had not reconciled to statements.
How brokers fit in
A good intermediary can surface peg landmines early. If you are exploring a business broker London Ontario community, ask what their typical working capital mechanism looks like. Some brokerages educate sellers on pegs from the first valuation meeting, which prevents painful renegotiations. I have seen outfits like liquid sunset business brokers gather month‑end net working capital for the past two years as a standard data pack. That habit alone can shave weeks off diligence for buyers scanning a small business for sale London or a business for sale in London Ontario. Sunset business brokers, likewise, will sometimes pre‑agree accounting policies with the seller’s accountant. When the other side is that prepared, negotiations feel like joint problem solving, not trench warfare.
A numeric walk‑through
Assume you are buying a London‑based distributor with 8.5 million pounds in revenue. Historically, net working capital by month ranged between 820,000 and 1,150,000 pounds, with an average near 980,000. Inventory is valued at average cost and turns 6.5 times per year. Receivables average 52 days, payables 41 days. VAT returns quarterly.
You agree, in the SPA, to include trade debtors net of provisions, inventory at average cost net of obsolescence using a 12‑month 50 percent, 24‑month zero policy, and prepayments. On the liability side, you include trade creditors, accruals for audit and payroll, and deferred revenue for prepaid maintenance contracts. Exclusions include corporation tax, VAT payable or receivable, lease liabilities, and any customer deposits for undelivered projects, which are treated as debt‑like and reduce price.
Using the last twelve months, excluding a one‑off stock build in August tied to a supplier strike, you set the peg at 980,000. Close date is the 20th of a month, but completion accounts will be drawn at month‑end. When the completion accounts land, net working capital on the agreed basis is 1,060,000. You pay the 80,000 surplus to the seller with the completion adjustment. Everyone is content.
Now imagine the facts shift. The seller had just negotiated 60‑day terms with their top supplier, but the buyer cannot secure the same. Terms revert to 45 days post‑close. That 15‑day delta, applied to average monthly purchases of 400,000, means 200,000 less supplier float. If the peg ignored this reality, the buyer would fund the gap. You have two options. Adjust the peg down 200,000, or keep the peg but reduce price by 200,000 as a separate item. Either way, tie the math to evidence, like supplier letters confirming post‑close terms.
Cross‑border nuance: London and London, Ontario
Local tax and banking practices change the rhythm of working capital. In the UK, VAT can flip a month. Payroll often runs on the last banking day, and PAYE impacts accruals. In Canada, HST and source deductions follow different calendars. Banking cutoffs differ. Many small businesses in London, Ontario rely on operating lines secured by receivables. When those lines exist, you must separate the bank loan, a debt item, from the receivables cycle that informs the peg. If you are reviewing a business for sale london, ontario through a community board rather than a formal broker, expect to build the peg from scratch because historical monthly working capital reports may not exist.
Payment culture differs too. UK corporates can be formidably slow payers unless you enforce terms. Canadian customers in construction might be fast payers but hold back retainage. These distinctions do not change the concept, only the inputs.
Negotiation rhythm that works
I like to raise peg methodology at LOI stage. You do not need the number yet, only the rules. Then use diligence to collect proofs that let both sides compute the peg objectively. If the seller understands the mechanism early, they will not feel sandbagged when you present a number.
A simple, effective sequence looks like this:
- Put peg methodology and accounting policies in the LOI. Gather monthly balance sheets for at least 24 months and reconcile to trial balances. Agree on debt‑like items before final price negotiations. Build a draft peg and walk the seller through movements month by month. Document counting and measurement procedures for completion, including inventory counts and cutoff tests.
This structure removes heat from the discussion. When someone objects, you can point to the agreed method rather than a number that feels unfair.
Documentation makes or breaks the post‑close adjustment
Completion accounts usually land 30 to 90 days after closing. By then, the founder is on holiday and the finance manager has a new job title. If you do not codify the measurement basis, a simple query about an accrual turns into a half‑day scavenger hunt. Write a short memo that sits behind the SPA schedules. Include sample calculations, a worked example for obsolescence, and specific GL codes included or excluded. For inventory counts, include an example count sheet with acceptance criteria for damaged goods. If you are dealing with a small business for sale London Ontario where the accounting function is thin, volunteer to help draft this memo. It will save everyone time.
Practical red flags and fixes
Two patterns put pegs at risk.
First, aggressive pre‑close behavior. Sellers may accelerate receivables with discounts, slow payables, or run down inventory. Not all of that is bad. Some is normal pre‑close housekeeping. Your job is to define what “ordinary course” means and set covenants to match. If DSO jumps from 48 to 35 in the last six weeks, ask why. If payables creep from 40 to 70 days, talk to suppliers.
Second, accounting blind spots. Many owner‑managed companies book adjustments only at year‑end. Obsolescence reserves, bonus accruals, and deferred revenue can be missing from monthly numbers. When you compute the peg off monthly data, incorporate a pro forma layer that reflects year‑end adjustments and apply it consistently. Then you are comparing apples to apples.
If a seller resists, offer a trade. Keep their simpler monthly approach for speed, and protect yourself with completion accounts rather than a locked box. Or agree a locked box with a specific list of leakage protections that cover the missing items.
When the peg is the deal
Sometimes the peg reveals that the business needs more capital than the buyer can or wants to fund. That is not a failure. Better to learn this before you buy. I once passed on a facilities maintenance group in West London. Brilliant client list, thin margins, and a working capital cycle that required an extra 1.2 million pounds to keep technicians in the field after a planned contract win. We could have set a peg that reflected the past, but the future needed more cash. The seller preferred a buyer who would take that bet. Right call for both sides.
In London, Ontario, I saw the opposite. A precision machining company had conservative inventory buys every December for tax planning. The peg, set on a 12‑month average, looked heavy. We rebuilt it using a 24‑month dataset and separated December anomalies. The peg fell by 180,000 Canadian dollars. Price stayed, and the seller felt seen. The buyer avoided paying for a tax tactic they would not repeat.
Where to look for help
If you are evaluating a small business for sale in London or scanning for buying a business London opportunities, you can get a long way with your own spreadsheet, the target’s monthly balance sheets, and supplier statements. If you are new to this, experienced advisors earn their keep when policy choices and debt‑like items get tricky. Local brokers and M&A accountants in both Londons can translate quirks in VAT or HST and typical supplier terms. Firms that regularly list business for sale in London ontario or advise those looking to buy a business in London ontario have sample SPAs with clean working capital schedules. Ask for redacted examples. You will learn more from one real schedule than five blog posts.
You can, of course, buy off market. I like off market business for sale deals because the seller is usually more open about their rhythms. It is easier to sit side by side and trace how receivables spike after a particular event or how inventories build for a seasonal push. Use that access to make the peg a joint exercise.
Final thought
A good peg is not about beating the other side. It is about making sure the business you buy arrives with the fuel it needs to run as expected. Price, structure, and even culture fit hinge on that shared expectation. If you handle working capital pegs with the same care you bring to valuation, your first quarter as owner will feel steady rather than breathless. And if you ever find yourself at a completion meeting arguing about whether customer deposits are debt‑like, remember this line, scope first, math second. Everything else follows.