Working Capital Adjustment
A contractual mechanism that adjusts the final sale price based on the gap between actual working capital at closing and the target agreed between the parties.
Definition
The working capital adjustment is a mechanism written into the purchase and sale agreement that corrects the transaction price based on the actual level of working capital on the day of closing.
In French-language Quebec documentation, you’ll see ajustement du fonds de roulement used for the same concept.
The parties agree on a target (often called the “peg”) — typically the 12-month average of working capital — and the price is adjusted dollar for dollar if the actual level deviates from it.
If working capital at closing exceeds the target, the seller receives the difference. If it’s below, the price is reduced by the same amount. This mechanism ensures the buyer receives a business with enough operating liquidity to run normally.
Why the working capital adjustment matters in a business sale
The working capital adjustment is one of the most contested points in SME transactions in Quebec. The reason is simple: how it’s defined and calculated has a direct impact on what you walk away with.
A gap of a few hundred thousand dollars on working capital translates into an equivalent adjustment on the price.
As a seller, you need to understand that the buyer expects to receive a business with enough liquidity to cover its current obligations.
If you accelerate collection of accounts receivable, delay supplier payments, or reduce inventory in the months before closing, working capital will be artificially low — and the price will be reduced accordingly.
Negotiating the target is just as important as negotiating the price itself. A target set too high forces you to leave more liquidity in the business.
A target too low can raise buyer suspicion and complicate negotiations. Your broker and your accountant need to work together to set a fair, documented, and defensible target.
What every seller should know
- The definition of working capital in the agreement has to be precise: which items are included (accounts receivable, inventory, prepaid expenses) and excluded (long-term debt, excess cash). Every ambiguous line is a potential source of dispute.
- Keep a normal operating cycle in the 6 to 12 months before closing. Unusual behaviour (aggressive collections, stretched payment terms) will be detected and penalized.
- Require a clear adjustment mechanism in the letter of intent, not just in the final agreement. Postponing that negotiation shifts the balance toward the buyer.
- Plan for an audit or review of working capital at closing — the parties generally have 60 to 90 days after closing to finalize the calculation and settle any gap.