When selling a business, the owner rarely walks away with the full headline amount. This is because of the NWC peg. See how this impacts a business sale.

 

Beyond the Headline Price: Mastering the NWC Peg

When a business sells for $10 million, the owner rarely walks away with that exact amount. The reason for this is because of net working capital, and sometimes this can be 20% or more of the price. It’s the hidden cost of almost every M&A transaction, and sellers who don’t understand it are leaving a significant amount of money on the table.

What Is Net Working Capital?

Net working capital (NWC) is the difference between a company’s operating current assets and operating current liabilities. In simpler terms, it measures the business’s short-term liquidity and whether it has enough resources to cover immediate obligations.

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To learn more about how working capital ‘peg’ can impact the sale of your business, contact our team at OCX Advisors today.

How the NWC Peg Works

In most middle-market deals, the buyer and seller agree on a net working capital, otherwise known as the “peg”. This is the amount of working capital that must remain in the business at closing, so the buyer can operate the business from day one without adding additional capital. 

The peg is decided by averaging the company’s normalized NWC over the trailing 12 months. Using a year-long timeframe provides a smooth average and filters out short-term fluctuation, giving both parties a fair baseline. 

During closing, if NWC exceeds the peg, the seller receives the excess. If NWC falls short, the difference is deducted from the purchase price. Either way, peg directly impacts the final price of the sale. 

How NWC Affects Cash-to-Seller

During a sale, NWC can impact the agreed headline price in the letter of intent. If the working capital falls below the agreed peg, the missing capital will be deducted from the purchase price. 

For example, if the peg is set to $1.5 million and the NWC comes in at $1.2 million, the seller has $300,000 less than expected. To fulfill the contractual agreement, $300,000 will need to be deducted from the agreed sale price to fulfill the peg.

Adjusting for Seasonality

When creating a peg based on the NWC, seasonal revenue needs to be considered. 

A retailer, for instance, a firework retailer, will have a very different NWC in July than they would in February. If the peg is based on a short look-back period, the seller could be at a clear disadvantage. 

Because of this, sellers in seasonal businesses should push for a trailing average. Such an average reflects the full cycle rather than just a snapshot that favours the buyer. 

The Debt-Free, Cash-Free Myth

Most M&A transactions are structured on a “debt-free, cash-free” deal structure. In this case, many sellers think they should withdraw every penny from the operating account before closing. However, this is incorrect. 

“Cash-free” refers to excess cash above the business’s operational cost. A portion of that cash is operating working capital, and it must remain in the business to meet the decided and agreed NWC peg. 

If you’d like to learn more about NWC pegs or need help acquiring or selling a business, feel free to contact us at OCX Advisors. Our team specializes in lower middle market M&A advisory to help you buy, sell, and scale a company.