Working capital pegs look simple on a term sheet. One number, a short footnote, and a nod during the management meeting. Then the deal gets into diligence and that single line drives a surprising amount of price, risk, and frustration. If you are buying or selling a company in London, the peg is the quiet hinge on which purchase price actually swings.
When I first started brokering lower mid-market deals, I treated the peg as housekeeping. After a few bruising closings, I learned it shapes how much cash a buyer brings on day one, whether a seller walks away happier than expected, and how clean the transition feels. It is even more sensitive in London’s mixed economy, where a Kensington creative studio, a Park Royal distributor, and a Croydon facilities contractor can show wildly different working capital rhythms across the same quarter.
A quick definition helps. The working capital peg is the target level of net working capital, delivered at completion on a cash-free, debt-free basis. If the business delivers more than the peg, sellers often get paid more. If it delivers less, buyers pay less. Straightforward in theory, but the choice of that target drives a quiet negotiation about seasonality, growth, revenue recognition, and what counts as a current liability in this specific business.
Why the peg matters more than most people think
Price headlines are seductive. You might agree 8.0x EBITDA and feel done. But buy-side models assume the business arrives with enough fuel in the tank to operate on day one. That fuel is working capital. If the business turns up light on receivables, heavy on payables, or with a spiky stock position after a promotional push, cash demands land on the buyer immediately. The peg is meant to stop either side from being stranded.
In London deals where banks or unitranche lenders are involved, the peg can also affect debt availability. Lenders underwrite liquidity. Turn up below peg, and a facility that looked flush becomes tight by week six. I have seen a perfectly healthy Battersea e-commerce seller creep under covenants after completion only because its peg ignored the normal pre-Christmas inventory build. No operational failure, just a mis-specified target.
Sellers should care because if the peg is set above the true normal, they end up financing the business beyond closing. That is money left on the table. If the peg is too low, buyers inherit a deficit and start life putting in extra cash. The peg protects fairness when chosen with care, and punishes sloppiness when treated as clerical.
What counts as working capital, and what does not
In a typical UK share sale on a cash-free, debt-free basis, net working capital includes trade receivables, inventory, prepayments, less trade payables, accruals, and deferred income. Cash is excluded from the purchase price mechanics unless otherwise agreed. Debt-like items, even short-dated ones, are not working capital. HMRC payables related to historic liabilities, unpaid bonuses earned pre-completion, lease incentives, and dilapidations often get carved out as debt-like.
The grey zone usually shows up in three places. First, deferred revenue. For agencies, SaaS firms, or maintenance-heavy businesses, this can be material. If the customer has paid, but the service is still to be delivered, that is a current liability. Second, rebates and chargebacks for distributors. If you owe suppliers for volume rebates or marketing co-funding, buyers typically see those as operational accruals that belong in working capital. Third, VAT. Whether VAT receivable or payable sits in the working capital definition depends on timing and drafting. In UK practice, it is often included, but I have seen carve-outs both ways.
There is also the question of normalisation. If the company just closed a one-off bulk buy at a discount, the bloated stock number might not represent normal. Conversely, if a seller has been running down stock ahead of a sale to window-dress cash, the understuffed inventory should not anchor the peg either. The same holds for receivables if a pre-deal collections sprint compresses debtor days in a way that will not last.
How to find a sensible peg in real life
Start broad, then get forensic. Data that usually matters arrives in three layers:
- Averages and medians across 12 to 24 months. You want enough time to see seasonality. Many London businesses carry different levels of receivables and inventory across the tax year and school holidays, and some show a late spring uptick linked to major events. Trend direction, not just level. If the company is growing 20 percent year over year, absolute working capital likely rises even if days stay stable. A peg set from last year’s average will be too low for a growth spurt, and too high during a contraction. Operational drivers. Days sales outstanding, days inventory on hand, days payables outstanding. Averages can lie. If DSO swings between 28 and 55 days depending on client mix, the peg should reflect the weighted norm, not a flattering snapshot during a collections push.
As a rule of thumb in small to mid-sized London deals, I try to organise the last 18 months of monthly trial balances, then reconstruct net working capital each month using the agreed definition. Plot the line. Circle peaks and troughs. Ask why those points happened. Call the finance manager who actually posts accruals. Ask when the buy-side peak inventory build lands ahead of Christmas, Chinese New Year, Ramadan, or the tourist season. Ask the sales ops manager when the big clients pay. You will learn more in those ten minutes than in three rounds of legal drafting.
London specifics that complicate pegs
This city compresses multiple business models into short postcodes. That diversity creates a few recurring peg puzzles:
- Events, hospitality, and retail articulate around the calendar. If you are buying a South Bank venue or a West End retailer, the best version of normal is a rolling 12-month average with weights adjusted for the quarter you will close in. Agencies and studios often carry soft assets. A Shoreditch creative studio may have low inventory and variable work in progress. Pegs here depend on WIP recognition policies and whether billing is time-and-materials or fixed fee with milestone invoices. Misread WIP and you misprice the peg by hundreds of thousands. Construction and facilities management often run negative working capital, especially where clients pay mobilization fees. A Croydon contractor might look cash rich if the peg ignores deferred revenue and under-accrued subcontractor costs. Buyers need a clear view of committed, not just invoiced, costs.
Layer on top the financing climate. London lenders watch cash conversion with hawk eyes. If you promise a peg aligned with stable conversion, then show a post-completion dip, your first business review with the bank will be uncomfortable.
Completion accounts, locked box, and the peg
UK deals tend to swing between locked-box and completion accounts mechanisms. Each interacts differently with the peg.
In a locked-box deal, you fix price using a historical balance sheet, typically the last audited numbers at a specified date. Sellers warrant no leakage from the box to completion, apart from permitted leakage like salaries. The working capital peg still appears, but it is often less contentious because the target is embedded in the locked-box date numbers. The risk is if the business seasonality means the locked-box date sits at an odd point in the cycle. You can adjust for that with an explicit peg adjustment or a targeted collar.
In completion accounts, the price adjusts after closing based on the actual completion balance sheet. Here the peg matters a lot. Parties agree a target, often the average of the last 12 months under an agreed definition, and then true-up after completion. You can include a collar to prevent small fluctuations causing payments back https://telegra.ph/Liquid-Sunset-Business-Brokers-The-London-Ontario-Buyer-Playbook-03-25 and forth. Definition precision matters here. The last thing either side wants is a month-long tussle over whether deferred payroll taxes should sit in working capital or debt-like items.
Collars, floors, and the art of a peaceful true-up
I like collars, particularly for deals where the last 12 months show an honest, narrow band of working capital movement. A common approach is to set a peg range, say 1.8 million to 2.0 million. If the delivered amount lands within the range, no adjustment. If it comes in at 1.6 million, the price adjusts to the bottom of the range rather than pound-for-pound. Likewise on the upside. Collars keep lawyers from sending twelve letters about a 30,000 swing.
Floors can be useful when a buyer fears a pre-completion drain, especially if the seller operates a group cash sweep. A minimum working capital on completion forces the seller to leave real substance behind. Sellers, for their part, should prefer a collar that stops runaway upside from evaporating into a microscopic calculation.
What buyers get wrong, and what sellers get wrong
Buyers often underestimate how operationally specific working capital is. They apply a generic 45-day DSO to an agency that bills 30 days but collects 52 from enterprise clients. Or they treat consignment inventory as owned stock. Or they assume the purchase order backlog converts to receivables on a smooth line. Then the peg turns into a frustration tax after closing.
Sellers sometimes underplay deferred revenue and accrued costs. An events company that takes deposits for summer weddings carries a liability until it hosts the event. If that sits too lightly in the accounts, the peg will rise during diligence, and the price tag drops. I have seen the opposite too, where a founder ran down stock to dress cash pre-sale, not realizing the buyer would rebuild inventory three weeks after closing and deduct the shortfall at true-up.
A practical path to a fair peg
Here is a straightforward approach that works in most London deals and avoids prolonged friction:
- Map the last 18 to 24 months of monthly working capital under the draft definition. Use trial balance data to reconstruct consistently. Identify abnormal months. Document the cause of each spike or dip and adjust the trendline mentally, not in the numbers, so the history remains intact. Check growth direction. If revenue is rising sharply, build a pro forma scenario to see what working capital would be at the new run-rate with stable days. Choose a base period that matches the closing season. If the deal will close in late Q3, give more weight to the same months last year and the recent quarter. Draft clean definitions with examples. Put sample calculations in an appendix so there is less room for interpretation at true-up.
Two brief vignettes from recent deals
A marketing agency in Shoreditch showed handsome cash conversion on paper and a modest inventory footprint, so the early peg talk felt easy. The buyer and seller agreed to use the last twelve months’ monthly average. Mid diligence, we realized the studio had several fixed-fee campaigns billed 40 percent upfront, 40 percent at milestone two, and 20 percent at completion. Work in progress was lightly measured, and revenue was recognized a bit ahead of delivery. Once we rebuilt WIP and deferred revenue properly, the peg moved by 240,000. It was not a trick, just the reality of creative work. We solved it by fixing a peg range and adding a narrow collar. The seller still got full value, and the buyer knew they were not taking over with a liability surprise.
A Park Royal wholesaler importing homewares looked lumpy on inventory because of shipping delays and a once-a-year container discount. The seller wanted the peg set at the low-stock spring month. We rebuilt the last 18 months using landed cost and consistent obsolescence reserves. The true normal sat 600,000 higher than the seller’s preferred peg. We bridged the gap by adding a small earnout tied to gross margin stability, which let the seller prove that the stock position would convert as promised.
Edge cases worth pausing over
Growth throws a wrench into averaging. If your Kensington DTC brand is doubling annually, a peg set off last year’s working capital starves the business after closing. Buyers should model the steady-state days and apply them to the new sales run-rate. That often lifts the peg by 10 to 25 percent over a naive trailing average.
Decline has the mirror problem. If a facilities firm lost two big contracts and revenue is down 15 percent year over year, the peg should drop accordingly. Otherwise, buyers end up paying for working capital the business no longer needs.
Revenue recognition policies can also flip expectations. A consultative SaaS vendor with annual prepayments will usually run negative working capital because deferred revenue outruns receivables. That can be a feature, not a bug, but both sides need to agree how to treat implementation costs, support backlog, and unearned revenue in the peg.
Lastly, VAT timing at quarter-end can swing working capital by six figures in smaller businesses. If your completion date lands a week before a VAT payment, your current liabilities are elevated. Some parties exclude VAT balances from the peg. Others accept the noise and size a collar to dampen it. Clarity beats cleverness here.
Drafting the definition so it holds under stress
Legal drafting should follow the finance work, not lead it. Still, a few clauses save heartache:
- Enumerate what is inside and outside working capital, using schedule references to specific trial balance codes. Ambiguity causes arguments. Define inventory at the lower of cost and net realisable value. State how obsolescence reserves apply and who sets them post-completion for the true-up. Specify treatment of deferred revenue with a clear method for measuring undelivered performance obligations if the accounting policy lacks detail. Include a worked example. Even a half-page sample avoids hour-long calls while tempers are high after closing. Set a collar or threshold for adjustments below a de minimis amount, so no one argues about a 5,000 swing three months later.
A quick checklist for buyers and sellers
- Confirm the period you are averaging matches the season in which you will close. Rebuild net working capital monthly using a consistent definition before you agree the peg. Stress-test for growth or decline by applying stable days metrics to the current sales run-rate. Decide early how to treat deferred revenue, rebates, VAT timing, and debt-like accruals. Add a collar or range so that only meaningful variance adjusts the price.
A short, real-world method to set your peg this week
- Pull 24 months of monthly trial balances and management accounts. Define net working capital in a one-page memo. Include or exclude VAT explicitly. Build a simple spreadsheet that calculates monthly working capital from the same GL codes. Mark anomalies and annotate why they happened. Keep the numbers pure. Pick a target and a narrow collar that reflect seasonality and the expected closing month.
Where brokers can help without overcomplicating
An experienced broker should not just pass paper between lawyers. On the sell side, I like to see a pre-deal working capital memo that explains the rhythm of the business before buyers even ask. That sets expectations early and reduces the sense that the seller is shifting targets mid-process.
A firm like Liquid Sunset Business Brokers has an advantage here because they see a volume of deals across categories, from a small business for sale London listings to more specialised off market opportunities. When you have handled a Hammersmith distributor one month and an Islington creative agency the next, you learn how to translate operations into working capital language that lenders and lawyers accept. If you are scanning companies for sale London and you plan to buy a business in London with debt, ask the broker for a monthly working capital bridge. If they produce it with confidence, you are in capable hands.
I have seen the same value play out in London, Ontario. Different market, similar pitfalls. A heating and cooling company there showed tight cash cycles until we accounted for a winter inventory build and manufacturer rebates paid quarterly. The peg moved by 180,000 once we modelled those flows. Brokers who work both sides of the Atlantic, whether listed as Liquid Sunset Business Brokers or a local business broker London Ontario, tend to standardise these practices. Good habits travel.
If you are a seller preparing quietly, a low-profile process can still be rigorous. For owners considering an off market business for sale route, a clean working capital narrative attracts better buyers and shortens diligence. It also keeps the final week before closing calm, which your staff and your nerves will appreciate.
How to keep working capital steady between signing and completion
The period between signing and completion invites drift. People celebrate, the finance team breathes out, and suddenly a few invoices go out late, stock counts slide, or a supplier payment holiday creeps in. That drift costs money at true-up. Bake a few simple behaviours into the transition plan:
Keep billing on schedule. If your agency invoices at month end, do not adjust timing to flatter cash or receivables. Keep inventory practices consistent. If you plan a buy-ahead for a promotion, tell the buyer and treat it as shared knowledge. Freeze accounting policies. No new thresholds on bad debt reserves or obsolescence just before closing. Communicate weekly on working capital movements. A two-page email avoids nasty surprises on completion accounts day.
Buyers can help by agreeing a set of ordinary course covenants that let the business operate without fear of breaching the SPA. Sellers can help by avoiding last-minute supplier payment holidays that look clever but shave the price later.
A note on small deals and simple pegs
Not every deal needs a 40-page appendix. If you are buying a very small business for sale in London, such as a single-shop retailer with steady trade, a pragmatic peg might be the average of the last six months with a modest collar. Keep the definition basic, include VAT, and run. For a small business for sale London Ontario with low inventory and fast cash sales, sometimes the peg is as simple as receivables plus prepaid rent less payables and accrued payroll. Proportionality matters. But even at this size, do not throw the peg away. A 30,000 surprise hurts more in a small company than a mid-market one.
What to watch during diligence to protect the peg
I watch debtor quality early. Ten largest receivables, ageing over 90 days, and any single customer concentration over 20 percent of revenue. If you see a sharp increase in 60 to 90 day buckets in the months before closing, tug that thread. In inventory-heavy businesses, do a floor walk, not just a spreadsheet tour. If stockrooms in Park Royal look different from the inventory register, they are. Ask how often cycle counts happen and how obsolescence is recognised. For deferred revenue models, ask for the schedule that ties payments received to delivery obligations, and ask the ops team to explain it, not just finance. If those stories diverge, build in time to reconcile.
A closing perspective from the trenches
The peg is not a trick. It is a translation layer between price and the living, moving parts that make a business function. Treat it as such. If you are a buyer, come to the table with a model that respects seasonality and growth. If you are a seller, pre-empt questions by showing your normal honestly and early.
The London market rewards that kind of preparation. Deals close smoother. Relationships stay warm. The first month after completion feels like the beginning of a partnership, not the aftermath of a scrimmage over spreadsheets. Whether you are working with a larger advisory team or a specialist such as Liquid Sunset Business Brokers on a business for sale in London or scanning businesses for sale London Ontario from across the pond, the discipline around the peg is the same. Define clearly, measure consistently, negotiate fairly, and leave both sides with a business that has enough fuel to run.