In M&A transactions, a Net Working Capital (NWC) adjustment is a post-close purchase price true-up that compares actual NWC at closing to a pre-agreed NWC target, with the purchase price adjusted dollar-for-dollar for any shortfall or excess. The SEC's Staff Accounting Bulletin Topic 5.T addresses purchase price allocation and working capital representations in acquisitions (https://www.sec.gov/interps/account/sabcodet5.htm).
Net Working Capital (current assets minus current liabilities) represents the cash a business leaves in operations at closing — inventory, receivables, and prepaid expenses minus payables and accruals. In an M&A deal, the purchase price is typically negotiated based on an assumed NWC level (the 'NWC target,' often set as a trailing 12-month average). If actual NWC at closing differs from the target, the purchase price adjusts to compensate. Mechanism: (1) At signing, parties agree on an NWC target (e.g., $1.2M) and a definition of what's included in NWC; (2) At closing, an estimated NWC is calculated and an initial adjustment is made to the cash consideration; (3) Post-close (typically 60-90 days), the buyer prepares a final NWC calculation; (4) If final NWC < target, the seller pays the shortfall to the buyer; if final NWC > target, the buyer pays the excess to the seller. Why it matters: NWC adjustments prevent a seller from 'draining' working capital before close (collecting receivables aggressively, deferring payables, liquidating inventory) — all of which would hand the buyer a cash-depleted business despite paying a price that assumed a fully-stocked working capital base. FASB ASC 805 (Business Combinations, https://www.fasb.org/standards/accounting-standards-updates) governs purchase price allocation in business combinations, including working capital representations. For SBA 7(a) acquisition loans: lenders underwrite NWC sufficiency as part of the business viability assessment. A business closing with below-target NWC may face an SBA lender requirement to inject additional equity to normalize working capital before the loan funds (SBA SOP 50 10 7.1, https://www.sba.gov/document/support-sba-standard-operating-procedures-sop-50-10).
The NWC target is typically negotiated as a trailing 12-month average NWC — calculated from monthly balance sheets over the prior year. This establishes a 'normalized' working capital level that reflects the business's ordinary operating cycle without seasonal distortions. The definition of what's included (e.g., whether certain cash balances or deferred revenue are in/out) is heavily negotiated and often the source of post-close disputes.
The 'peg' is another term for the NWC target — the agreed reference level against which actual closing NWC is compared. Some deals use a 'collar' or 'basket' around the peg: if actual NWC falls within $X of the target (say, ±$50K), no adjustment is made. Only deviations outside the collar trigger a cash settlement. This reduces transaction friction over small variances.
Yes. If a buyer owes a seller a post-close NWC true-up, that obligation can be financed as part of the deal structure — included in seller notes, earnout provisions, or a dedicated working capital line. Similarly, SBA lenders may allow a post-close working capital injection to be included in the total financed amount if documented at origination. Unplanned NWC obligations that arise post-close without prior financing are a common cause of early post-acquisition cash flow stress.