Working Capital Peg in PE Deals: Interview Explanation
What a working capital peg is in PE / M&A interviews: target NWC, purchase price adjustments, true-ups, and how to explain the economics simply.
PE · 4 min read
"What is a working capital peg?" shows up in PE and IB M&A interviews once you clear basic NWC. The peg protects both sides from the target delivering a hollowed-out balance sheet at close. Explain the fairness problem first, then the true-up math.
The short answer
"A working capital peg is a target level of net working capital the seller must deliver at closing. If actual NWC is below the peg, the buyer gets a purchase price reduction or cash true-up. If actual NWC is above the peg, the seller often gets an increase. It stops the seller from pulling cash out of AR, inventory, or AP timing right before close."
Why it exists
Enterprise value in a cash-free debt-free deal assumes a normal operating balance sheet. Without a peg, a seller could:
- Delay paying vendors (AP up, looks cash rich)
- Pull forward collections (AR down)
- Starve inventory
Those games change cash at close without changing the real operating need the buyer inherits the next morning.
Mechanics (interview level)
Define NWC
Usually current operating assets minus operating liabilities (exclude cash and debt).
Set the peg
Often average NWC over a lookback, normalized for seasonality.
Measure at close
Closing statement NWC versus peg.
True-up
Dollar-for-dollar or agreed adjustment to price / cash.
Simple true-up
Price Adjustment ≈ Actual Closing NWC − Peg NWC (positive → seller benefit; negative → buyer benefit; SPA controls sign and caps)
Mini example
Peg = $40. Closing NWC = $34.
Buyer shortfall = $6, so purchase price / equity value adjusts down by about $6 per the SPA. If closing NWC were $46, the seller would typically receive about $6 more, subject to caps, floors, and dispute mechanics.
Peg
40
Actual
34
Buyer credit
~6
Seasonality trap
A retailer with Christmas inventory should not use a January month as "normal" without adjustment. Interview answer: "I would set the peg from a seasonally aware average, not a single trough or peak month." Growth businesses also need care: a rising revenue run-rate may imply a rising "normal" NWC, so a trailing average can understate what the buyer needs.
Peg vs locked box
| Concept | Idea |
|---|---|
| Completion accounts + peg | Price adjusts for debt, cash, and NWC at close |
| Locked box | Equity value fixed at a historical locked box date; leakage rules apply |
Know that both exist. Do not mash them into one explanation. Locked box shifts economic risk from a locked date; pegs live in completion-accounts deals where closing NWC is measured.
How this hits the model
In an LBO sources and uses, you still fund the equity check implied by the SPA. Peg true-ups can change cash out at close slightly. For interviews, emphasize economics over SPA legalese. Connect the peg to Cash-Free Debt-Free and Net Debt Bridge so classification fights make sense.
Seller can strip operating WC into cash and inflate what buyer effectively pays.
Cash and debt-free price assumes a defined normal NWC; deviations true up.
Definition fights (where deals actually argue)
Most peg disputes are classification: is this item debt-like or working capital? Deferred revenue, customer deposits, accrued bonuses, income taxes, and related-party balances are classic fight zones. SaaS deals argue hard about deferred revenue in the peg because it is both a liability and a signal of future performance. Say you would read the SPA schedule rather than invent a universal rule.
Buyer and seller negotiation posture
Buyers push for a higher peg and a tight definition of what counts as NWC. Sellers push for a lower peg and exclusions that protect seasonal or one-time balances. In an interview, say the peg is negotiated economics, not a fixed accounting identity pulled from a textbook.
Follow-ups
- What is in NWC vs net debt?
- How do you treat deferred revenue in the peg? SPA-defined; often included carefully for SaaS.
- What if the business is growing and normal NWC is rising?
- Are there collars or de minimis thresholds before true-ups kick in? Often yes in the SPA.
30-second verbal
"A working capital peg is the target NWC at closing in a cash-free debt-free deal. Miss the peg and price adjusts so neither side wins by stuffing or stripping the balance sheet. I set it off a normalized, seasonality-aware average and true up actual versus peg."
Related
Working Capital Interview Questions, Working Capital in LBOs, Sources and Uses, and Cash-Free Debt-Free.
Practice on SheetRank
On Project Apollo, sketch a peg, a closing NWC miss, and the equity check change. Narrate why the buyer is not "getting a bargain" when NWC is low: they are inheriting a thinner operating balance sheet.
Practice on SheetRank
Apply what you learned with drills, guided Academy builds, and live deal underwriting.