Working capital adjustments in LMM LOIs

Working capital is the deal term that gets the least attention in the LOI and causes the most damage at close.

Most LOIs define the working capital peg as "to be determined based on a 12 month average of net working capital, calculated at close." That sentence is where leverage walks out the door. Every imprecise word in that definition becomes a renegotiation lever in the true up post close.

This piece walks through the mechanics of working capital adjustments in lower middle market deals, the precise terms that need to be locked down in the LOI, and the language that protects sellers from late stage retrade attempts.

Why working capital matters

Buyers and sellers agree on a purchase price assuming the business comes with a "normal" amount of working capital, enough cash, receivables, inventory, and prepaid expenses to operate the business without immediate additional investment.

If the business closes with more working capital than the agreed peg, the seller gets the excess (paid out at close or in true up). If the business closes with less, the buyer reduces the purchase price to compensate for the shortfall.

Sounds simple. The complexity lives in three things: what counts as working capital, how the peg is calculated, and how the true up gets resolved.

The three terms to lock down before signing exclusivity

1. The reference period

"12 month average of working capital" is ambiguous. Which 12 months?

The buyer wants the period that minimizes the peg (so the closing balance exceeds the peg, and the seller has to add cash at close, or the buyer takes a price reduction). The seller wants the period that's most representative of normal operations.

Define the period specifically:

• Trailing 12 months ending at the most recent month end before LOI signing
• Or trailing 12 months ending at LOI signing date
• Or specific calendar period (e.g., "the 12 months ending December 31, 2025")

What to avoid: "trailing 12 months ending at close" or "12 month average up to close." These let the buyer pick the worst 12 month period for the seller.

What to consider for seasonal businesses: average of all months versus excluding seasonal extremes. A retail business has high working capital in November and December (inventory build for holidays). Including those months in the average inflates the peg artificially.

2. The components

Net working capital is current assets minus current liabilities. But which line items?

Standard inclusions:

• Accounts receivable (trade)
• Inventory
• Prepaid expenses (operating, not deal related)
• Accounts payable (trade)
• Accrued expenses (operating)

Standard exclusions (target balance is zero or excluded):

• Cash and cash equivalents (target zero unless specified otherwise)
• Debt and debt like items
• Income taxes payable
• Capital expenditures accrued
• Deal related costs

Negotiation points where real dollars move:

• Accrued bonuses (especially year end). Are these included in NWC? If yes, the buyer pays more. If no, the seller pays.
• Deferred revenue. Working capital item or debt like? Treatment varies by sector.
• Customer prepayments. Similar question.
• Capex accruals. Often debated. Treat as debt like to exclude from NWC.

Each line item is worth real dollars at close. The LOI should define net working capital with specific inclusions and exclusions, not a generic "net working capital as defined under GAAP."

3. The true up window

The true up is the post close calculation of actual closing working capital versus the peg.

Standard timeline:

• Buyer calculates actual closing NWC within X days of close
• Seller has Y days to dispute
• If disputed, neutral accountant resolves within Z days
• Final amount is paid (by either party) within W days of resolution

Default ranges in LMM deals:

• Buyer calculation: 60 days post close
• Seller dispute window: 30 days
• Neutral accountant resolution: 60 days
• Payment: 30 days post resolution

Push for tighter windows. Every extra day favors the buyer (their calculation is the working number; the seller has to fight to change it).

The retrade vector

Working capital is a common retrade vector for buyers in late stage exclusivity.

Around week 6 to 8 of diligence, the buyer's QofE provider analyzes working capital. They typically find:

• Higher receivables aging than expected (signals collection problems)
• Inventory carrying values inflated (signals shrinkage or obsolescence)
• Accrued bonuses higher than the peg assumed
• Deferred revenue that should be treated differently

The buyer comes back with: "Our analysis shows working capital is materially below the LOI peg. We need to revisit." The amount is often framed as "small" because it's spread across multiple line items, but the cumulative impact moves real dollars.

The defense is upstream. A precise reference period, specific component definitions, and tight true up windows in the LOI close most of these retrade vectors before they open.

The math example

Consider a deal at signing:

• LOI working capital peg: ~$5M (loosely defined)
• Actual closing NWC after buyer's QofE analysis: ~$3.5M
• Adjustment: ~$1.5M reduction in seller proceeds

If the LOI had defined working capital precisely (specific reference period, specific components, specific calculation methodology), the analysis at close would have produced a peg closer to actual. The adjustment would be smaller. Often immaterial.

Sample LOI language

Tight working capital language:

Specific. Defined. Dated. Capped. The buyer can negotiate every word, but the structure protects the seller.

Where to read next

For the broader LOI checklist that wraps the working capital decision into the full set of terms to lock down before exclusivity, see LOI and Exclusivity in Lower Middle Market M&A. For the timeline that frames where this conversation happens in the broader sell side process, see The Sell Side M&A Process: 26 Week Timeline. For the data room folder structure that exposes the working capital line items the QofE provider will analyze, see Sell Side Data Room Folder Structure.