Every quality of earnings report I’ve worked on flags the same two findings. The first is predictable. The second is where price quietly moves.
1. Add-back rejections
A seller walks in with $400K of add-backs: owner comp, family payroll, “one-time” legal fees, personal expenses run through the P&L. The QoE accepts $150K. That gap times the multiple comes straight off the purchase price.
2. The net working capital peg
Net working capital is, roughly, what the business needs to keep running day to day: receivables plus inventory, minus payables and accrued expenses.
Buyers expect the business to come with a normal level of working capital. So the purchase agreement sets a target, the peg, usually based on a trailing twelve-month average. At closing, actual working capital is compared to the peg:
- Above the peg: the seller usually gets paid the difference.
- Below the peg: the seller usually owes the difference.
How sellers lose money here
Heading into a sale, owners often run lean without realizing what it does at closing. They collect receivables hard, slow down payments to vendors or let inventory run down. Cash looks great. Working capital at close comes in below the peg, and the seller pays it back.
Example: the peg is set at $2.0M. At closing, working capital is $1.6M because the owner pushed collections and let inventory run low. The seller owes the $400K gap, often out of the purchase price.
The first finding hits the headline. The second quietly moves 3% to 7% of enterprise value.
The fix
- Model working capital monthly for at least a year before a sale, so you know your normal level and seasonality.
- Don’t run the business differently heading into close. Keep collecting, paying and stocking the way you normally do.
- Negotiate the peg with real data, including seasonality, not a number the buyer picks.
- Pressure-test your add-backs to the standard of a top-tier QoE team, and pull the ones you can’t defend.
Common questions
Who sets the working capital peg?
It’s negotiated. The buyer usually proposes it, often based on a trailing twelve-month average. Sellers should come with their own analysis, including seasonality.
Does cash count in working capital?
Usually not. Most middle-market deals are done on a cash-free, debt-free basis, so cash is handled separately and working capital means operating items like receivables, inventory and payables.
What if my business is seasonal?
Seasonality matters a lot. If you close at a low point in your cycle, working capital may look short against an annual average. Bring monthly data to the negotiation.
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