Working Capital Adjustment

Why Working Capital Adjustments Exist

The enterprise value of a business is typically agreed based on an assumption that the business contains a normalised level of working capital at closing — enough to continue operating without the buyer needing to inject additional capital immediately after purchase.

Without a working capital adjustment, a seller could reduce working capital before closing — by accelerating collections, delaying payables, or reducing inventory — effectively extracting value from the business at the buyer’s expense. The working capital adjustment prevents this by measuring actual working capital at completion and adjusting the price accordingly.

The Mechanics

A working capital adjustment follows these steps:

Step 1: Define Working Capital

The SPA defines which items are included in the working capital calculation. A typical definition:

Working Capital = Current Assets − Current Liabilities

Common inclusions:

• Assets: Trade receivables, inventory, prepaid expenses, other current assets
• Liabilities: Trade payables, accrued expenses, deferred revenue, other current liabilities

Common exclusions (handled separately):

• Cash and cash equivalents (dealt with as part of net debt)
• Interest-bearing debt (net debt)
• Tax liabilities and assets (often dealt with separately in tax warranties or indemnities)
• Transaction costs

Step 2: Set the Target

The parties agree a working capital target — typically the average or normalised working capital over the preceding 12 months. This is calculated during due diligence based on historical management accounts.

Step 3: Measure at Completion

After completion, the seller prepares completion accounts showing actual working capital at the completion date. The buyer reviews and accepts, or disputes, these accounts. Disputes are resolved by an independent accountant expert.

Step 4: Calculate the Adjustment

• If actual working capital > target → buyer pays the excess to seller
• If actual working capital < target → seller pays the shortfall to buyer

The adjustment is typically settled within 30–60 days of completion accounts being agreed.

Example

A software business has been trading with average working capital of $2.5M over the past year. The parties agree a working capital target of $2.5M in the SPA.

At completion, actual working capital is $2.1M — $400,000 below target.

The seller pays the buyer $400,000 as a working capital adjustment. The effective purchase price falls by $400,000 from the headline price.

Normalised Working Capital

Establishing the “right” working capital target is one of the most negotiated elements of M&A deals:

• Sellers prefer a lower target (so they are less likely to owe money post-completion)
• Buyers prefer a higher target (ensuring they receive more working capital with the business)

Best practice is to use a genuine trailing 12-month average, adjusted for seasonality. Businesses with seasonal revenue cycles — retail, agriculture, construction — need careful analysis to ensure the target reflects the actual normalised level rather than a point-in-time peak or trough.

Working Capital vs Net Debt

Working capital adjustment and net debt adjustment are separate mechanisms that together reconcile the headline enterprise value to the actual equity value paid:

Equity Value = Enterprise Value − Net Debt + Cash − Working Capital Shortfall (or + Surplus)

Net debt (borrowings minus cash) and working capital are both measured at completion accounts and both adjust the final price. Sellers with excess cash in the business benefit from a net debt adjustment; sellers who have operated the business lean on working capital may face a shortfall adjustment.

Locked Box Alternative

The working capital adjustment mechanism exists in completion accounts transactions. The alternative is a locked box structure, where the price is fixed at signing based on a historical balance sheet — and no post-completion adjustment is made. Instead, the seller gives a covenant against “leakage” (removing value from the business between the locked box date and completion).

Sellers typically prefer locked box because it provides certainty on the final price at signing. Buyers prefer completion accounts because they provide protection against deterioration between signing and closing.

	Completion Accounts	Locked Box
Price certainty	Lower (adjusts post-close)	Higher (fixed at signing)
Seller risk	Working capital shortfall risk	Leakage protection covenants
Buyer risk	Operates business pre-close with less visibility	Price risk between locked box date and close
Common use	Australia domestic deals	PE-to-PE; European market standard

Amafi’s Role in Working Capital Negotiations

Working capital target setting and the completion accounts process are among the most technically complex elements of M&A transactions — and among the most frequently litigated. Amafi works with sell-side clients during the preparation phase to:

• Calculate normalised working capital from historical accounts
• Model the impact of different target levels on net proceeds
• Negotiate the working capital target and definition in the SPA
• Review completion accounts prepared by the buyer and identify any calculation disputes

Getting this right protects proceeds — a $500K working capital adjustment dispute on a $20M deal is a 2.5% price impact.

Book a valuation meeting to understand how deal mechanics affect your net proceeds.

Related Terms

• Working Capital — the underlying concept and formula
• Share Purchase Agreement — the SPA governs the working capital adjustment mechanism
• Net Debt — the related adjustment for cash and borrowings
• Locked Box — the alternative to completion accounts; no post-closing adjustment
• Quality of Earnings — QofE analysis often identifies working capital normalisation adjustments