Corporate Finance Insights · March 2026 · 9 min read
When business owners think about what could go wrong in a sale process, they tend to focus on the obvious risks. A buyer pulling out. A valuation dispute. Tax complications. Legal issues discovered in due diligence. These are legitimate concerns, but in practice one of the most common and most costly reasons deals collapse, stall, or complete at a lower price than expected has nothing to do with any of them.
It is working capital.
Specifically, it is the failure to understand, prepare, and manage working capital in the months before and during a sale process. This single issue derails more transactions, generates more post-completion disputes, and erodes more seller value than almost any other factor in UK SME M&A. Often, business owners have never sold a business before, and they rarely see it coming until it is too late to do anything about it.
This guide explains what working capital is in the context of a business sale, why buyers focus on it so intensely, where the most common problems arise, and what you need to do to protect your position before a sale process begins.
What Working Capital Means in the Context of a Business Sale
Working capital is the difference between your current assets and your current liabilities. In its simplest form it represents the liquid resources available to keep the business operating day to day. Current assets include cash, trade debtors, and stock. Current liabilities include trade creditors, accrued expenses, and other short term obligations.
In normal business management, working capital is monitored to ensure the business has sufficient liquidity to meet its obligations as they fall due. In the context of a business sale, working capital takes on a different and considerably more significant role.
When a buyer acquires a business, they are not just buying the earnings. They are buying the operational infrastructure required to generate those earnings, and that infrastructure includes the working capital embedded in the business. A buyer completing on a transaction expects to receive a business that is fully funded to trade at its normal operational level from day one of their ownership. They are not expecting to inject additional cash to cover a working capital shortfall created by the seller’s pre-sale behaviour.
This expectation is formalised through what is known as a working capital peg, one of the most consequential and most frequently misunderstood elements of any business sale agreement.
The Working Capital Peg: How It Works and Why It Matters
The working capital peg is the mechanism by which buyers and sellers agree on the level of working capital that should be present in the business at completion. It is typically negotiated as part of the heads of terms and then documented in detail in the sale and purchase agreement.
The process works as follows. The parties agree on a target working capital figure, usually derived from a normalised average of the business’s working capital over a trailing period of twelve to twenty four months. This normalised figure represents the level of working capital required for the business to operate at its current run rate without disruption.
At completion, the actual working capital in the business is measured against the agreed target. If the actual figure is above the target, the seller receives an upward adjustment to the purchase price. If the actual figure is below the target, the buyer deducts the shortfall from the consideration payable to the seller.
The practical implication is significant. A working capital shortfall of £200,000 at completion on a transaction valued at £5 million reduces the seller’s actual proceeds by £200,000, regardless of what was agreed on headline price. And in many cases, the working capital adjustment at completion is the first time a seller fully understands the financial consequences of decisions made in the months leading up to the sale, when up until this point, much of the focus will have been on the businesses adjusted EBITDA.
Why Buyers Focus on Working Capital So Intensely
Buyers and their advisers approach working capital with considerable rigour during due diligence, and understanding why helps sellers appreciate what they need to prepare for.
It reveals the true quality of the business’s earnings. Working capital dynamics tell a buyer a great deal about how well a business is actually being managed. Consistent debtor days, stable stock levels, and well-managed creditor terms suggest a business with strong financial discipline. Erratic cash conversion, ballooning debtors, and stretched creditor terms suggest a business where the reported profitability may not reflect the underlying cash reality.
It identifies pre-sale manipulation. One of the most common patterns buyers look for is artificial working capital management in the period immediately before a sale. This typically involves accelerating cash collections to inflate the cash balance, extending supplier payment terms to defer cash outflows, or drawing down on credit facilities to present an inflated liquidity position. Experienced buyers and their financial advisers are adept at identifying these patterns, and when they do, the consequences go beyond a working capital adjustment. They raise questions about the integrity of the financial information presented more broadly and can trigger a more aggressive approach across the entire due diligence process.
It determines the funding requirement post-completion. A buyer who completes on a transaction with below-target working capital has to fund the shortfall from their own resources to maintain operational continuity. That is effectively an additional cost of the acquisition that was not visible in the headline price. Buyers factor this risk into their valuation and their negotiating position throughout the process.
The Most Common Working Capital Problems in SME Sales
Several specific working capital issues appear repeatedly in UK SME transactions, and being aware of them before a sale process begins is the most effective way to avoid them.
Debtor concentration and extended collection periods. A business with a significant proportion of its debtors concentrated in one or two customers, or with debtor days materially above the sector norm, will attract scrutiny. Buyers want to understand whether those debtors will actually be collected, whether the concentration represents a commercial risk, and whether the business has historically required effort to collect what is owed. Poor debtor management directly affects both the working capital position and the buyer’s confidence in the revenue quality.
Inconsistent stock management. For businesses carrying stock, the valuation, age profile, and liquidity of that stock is a working capital concern. Obsolete stock carried at full value on the balance sheet, or stock levels that have been built up artificially in the run-up to a sale, will be identified and challenged during due diligence.
Stretched creditor terms. A business that has extended its creditor payment terms significantly beyond their normal level in the period before a sale is creating a working capital position that will normalise after completion, at the buyer’s expense. This is one of the most common forms of pre-sale working capital management and one of the first things a quality of earnings analysis will identify.
Seasonal working capital requirements. Businesses with seasonal trading patterns have working capital requirements that vary significantly through the year. The completion date of a transaction can have a material impact on the working capital position at the point of measurement. Sellers in seasonal businesses need to understand how their working capital cycle interacts with the proposed completion date and ensure the normalised peg reflects the true average rather than a seasonal low point.
Intercompany balances and related party transactions. Where a business has intercompany balances with related entities, these are typically excluded from the working capital calculation and must be settled before or at completion. Sellers who have been using intercompany balances to manage liquidity across a group structure need to understand the working capital implications of unwinding those arrangements as part of the sale.
The Consequences of Poor Working Capital Preparation
The financial consequences of arriving at a sale process with a poorly prepared or poorly managed working capital position fall into three distinct categories, each of which costs the seller money.
Valuation reduction at offer stage. A buyer who identifies working capital concerns during their initial review of financial information will factor those concerns into their initial offer. Rather than raising them transparently, they will simply reduce the price they are prepared to pay and attribute the reduction to earnings quality or risk factors. By the time the seller understands what has happened, the negotiating anchor has been set at a lower level than it should have been.
Post-offer price chipping during due diligence. The working capital peg negotiation and the quality of earnings process are the two most common mechanisms through which buyers reduce the price they agreed at heads of terms. A seller who cannot produce a clean, well-documented normalised working capital analysis is in a weak position to defend the target level and will typically concede ground they should not have needed to concede.
Post-completion claims and disputes. Even after a transaction has completed, working capital disputes can arise. The completion accounts process, which involves preparing a final set of accounts as at the completion date and reconciling the actual working capital against the agreed target, is one of the most frequently contested elements of any business sale. Sellers who have not prepared thoroughly find themselves in a dispute with a buyer who has both the financial incentive and the contractual mechanism to pursue an adjustment.
How to Prepare Your Working Capital Position Before a Sale
The good news is that working capital issues are almost entirely addressable provided they are identified and managed with sufficient lead time. The following steps, ideally implemented twelve to twenty four months before a sale process begins, will protect your working capital position and your negotiating strength throughout the transaction.
Establish your normalised working capital baseline. Calculate your average working capital over the last two to three years on a monthly basis. Understand the seasonal patterns within that data and identify any periods where working capital was unusually high or low and why. This analysis becomes the foundation of your working capital peg negotiation and allows you to engage from an informed position rather than reacting to the buyer’s assumptions.
Tighten your debtor management. Review your debtor days against sector benchmarks and implement consistent credit control processes if they are not already in place. Reducing debtor days to a level consistent with your sector norm strengthens your working capital position and removes a common source of buyer concern. It also improves your cash conversion cycle in the period before the sale, which benefits you directly.
Normalise your creditor payment terms. If you have been extending creditor terms beyond their contractual basis, the period before a sale is the time to normalise them. Doing so early enough that the normalised position is reflected in at least two to three periods of management accounts removes the risk of a buyer identifying the issue during due diligence and treating it as manipulation rather than normal business management.
Address intercompany and related party balances. Identify any intercompany balances that will need to be settled at completion and understand their working capital implications. Take advice on how these should be treated in the working capital calculation and ensure they are documented clearly in your financial information.
Prepare supporting documentation. A working capital schedule supported by aged debtor analysis, stock reconciliations, and creditor listings gives the buyer’s advisers what they need to validate your normalised working capital figure quickly and with confidence. The more thoroughly you can document your working capital position, the less room there is for a buyer to construct an alternative and less favourable version of the same numbers.
How We Help Sellers Manage Working Capital Through a Transaction
Working capital preparation is one of the most technically demanding aspects of sale readiness and one of the areas where experienced corporate finance advice adds the most immediate and measurable value.
Our team works with business owners in the months before a sale process to establish a normalised working capital baseline, identify and address any issues that would attract buyer scrutiny, and prepare the documentation required to defend the working capital peg throughout the transaction. We also manage the completion accounts process on your behalf, ensuring that the post-completion working capital reconciliation is conducted fairly and that any adjustments reflect the genuine position rather than a buyer’s attempt to improve their outcome at your expense.
If working capital is not something you have thought about in the context of your sale, the time to start is now. The decisions made in the twelve months before a transaction are the ones that determine whether the price you agree at heads of terms is the price you actually receive at completion.
Frequently Asked Questions
What is a working capital peg in a business sale? A working capital peg is the agreed target level of working capital that should be present in the business at completion. If the actual working capital at completion is below the agreed target, the buyer deducts the shortfall from the purchase price. If it is above the target, the seller receives an uplift. The peg is typically calculated as a normalised average of the business’s working capital over a trailing period and is one of the most negotiated elements of any sale agreement.
How is normalised working capital calculated? Normalised working capital is calculated by taking the average working capital across a representative historical period, typically twelve to twenty four months, adjusted for any seasonal patterns, one-off items, or non-recurring movements. The goal is to arrive at a figure that represents the level of working capital genuinely required to operate the business at its current run rate on a sustainable basis.
Can working capital issues kill a deal entirely? Yes. In cases where working capital has been materially manipulated in the period before a sale, or where the working capital position is so far below the buyer’s expectations that the funding gap makes the transaction unworkable, deals do collapse. More commonly, working capital issues result in significant price reductions rather than outright deal failure, but the financial consequences can be substantial either way.
When should I start preparing my working capital position? Ideally twelve to twenty four months before you intend to launch a sale process. This gives you sufficient time to normalise any issues, build a clean financial record that reflects the true working capital requirements of the business, and prepare the documentation needed to defend your position during due diligence.
What is the difference between working capital and cash flow? Working capital is a balance sheet measure, the difference between current assets and current liabilities at a point in time. Cash flow is an income statement measure, tracking the movement of cash into and out of the business over a period. Both are important in the context of a business sale, but working capital is the specific metric around which the completion accounts adjustment mechanism operates.