Working Capital in a Business Sale

In short: Working capital is the money tied up in running the business day to day, the stock, the amounts customers owe you and the amounts you owe suppliers. In a sale it becomes a separate negotiation from the headline price, because a buyer expects to receive the business with enough working capital in it to keep trading normally from the day they take over. If the level at completion differs from the level agreed, the price is adjusted up or down accordingly. Sellers who have not thought about this until the offer arrives frequently find that the amount they actually receive is not the amount they agreed.

This is the part of a transaction owners understand least and the part that most often moves money at the last moment. It is worth understanding before you are in it. For the wider process of preparing a business for sale, our complete guide to business exit planning covers every stage.

Why does working capital form part of the price?

Because a buyer is acquiring a trading business, not a set of accounts.

Almost every sale is agreed on the basis that the buyer receives the company with no cash and no debt in it, with those balances settled or accounted for separately. Our article on how to extract cash from a company before selling looks at what happens to surplus cash. What cannot be stripped out is the working capital, because the business stops functioning without it. There has to be stock on the shelves, customers who owe money, and normal supplier terms in place.

So the buyer says, in effect, that the price assumes a normal level of working capital in the business at completion. Deliver more than that and the price goes up. Deliver less and the price comes down. The logic is straightforward. Establishing what normal means is not.

What is a working capital adjustment?

It is the mechanism that compares the working capital actually present at completion against the level the parties agreed as normal, and adjusts the consideration by the difference.

The agreed level is usually called the target, or the peg. Setting it is a negotiation informed by the trading history of the business, and both sides have an obvious incentive to pull it in opposite directions. A buyer wants the target set high, because anything below it reduces what they pay. A seller wants it set low for the same reason in reverse.

What makes this genuinely difficult rather than merely adversarial is that most businesses do not have a single normal level. Working capital moves with the seasons, with the timing of large invoices, with stock cycles and with how hard anyone happens to be chasing debtors that month. Choosing which period to average, whether to strip out unusual items, and how to treat balances that are technically current but practically dead is where the judgement sits. It is also where a seller without their own adviser tends to accept a definition drafted entirely for the buyer's benefit.

Completion accounts vs locked box: how is the final price fixed?

Two mechanisms dominate, and they allocate risk very differently. The choice is usually made early, often at heads of terms, and it shapes everything that follows.

How do completion accounts work?

The buyer pays an estimated price at completion. A set of accounts is then prepared after the deal closes, showing the actual cash, debt and working capital on the day of completion, and the price is adjusted up or down to match.

It is accurate, because the price reflects the business as it actually stood when ownership changed. The drawback for a seller is timing. The final figure is not known on the day you sign, the accounts are often prepared by the buyer, who now controls the company and its records, and disagreements over the figures can take months to resolve. Agreements usually set out a process for that, often involving an independent accountant, and the detail of that process matters more than most sellers realise.

How does a locked box work?

The parties agree the price by reference to a balance sheet at a date before completion, known as the locked box date, using accounts both sides have already seen. From that date, the economic risk and reward of the business pass to the buyer, even though the seller is still running it. There is no adjustment after completion, so you know the figure at signing.

Because the price is fixed early, the buyer needs protection against value being taken out of the business before they own it. That protection is the leakage provision, and it is where most of the negotiation on a locked box deal takes place.

What is leakage, and what is permitted leakage?

Leakage is value leaving the company for the benefit of the seller or people connected to them between the locked box date and completion. Typical examples include dividends, bonuses outside normal pay, management charges, payments to connected companies, debts owed by the seller being written off, and deal costs the company pays on the seller's behalf. The seller normally promises that none of this will happen and agrees to repay any that does.

Permitted leakage is the list of payments both sides agree in advance can carry on, such as normal salaries and specific items already planned. Anything not on that list is a breach. Owners of family companies are particularly exposed here, because payments that have always been routine, like a relative's salary or a recharge to another company you own, can count as leakage unless they are expressly permitted.

Some locked box deals also include a mechanism that pays the seller for profits the business earns between the locked box date and completion, sometimes called a profit ticker. Whether one is appropriate, and how it is worked out, is part of the negotiation.

How do the two compare?

Which suits a seller?

Neither is inherently better. Sellers often prefer a locked box for the certainty and the cleaner exit, while buyers often resist it where trading is volatile or the accounts are not strong enough to price from. Completion accounts can suit a business whose position changes quickly through the year, but they leave you exposed to a calculation performed after you have handed over control.

The quality of your numbers decides a lot of this. A buyer will only agree a locked box if they trust the balance sheet at the locked box date, and many owner managed companies are not audited, so reliable management accounts carry much of the weight. Take a Teesside distribution company with tidy monthly accounts that reconcile to its year end figures. It is in a far stronger position to ask for a locked box than a similar company whose numbers only make sense once its owner has explained them.

Why do sellers lose money here?

Because the adjustment is technical, it arrives late, and by the time it bites the seller has usually stopped negotiating.

The common patterns are consistent. A target set from a period that flattered the buyer. Debtor balances that will never be collected still counted as assets until the buyer excludes them at completion. Stock valued on a basis nobody scrutinised until it mattered. Accrued costs the seller did not think of as working capital being pulled into the definition. Deferred income treated as a liability that reduces the price, on contracts the seller regarded as won revenue. On a locked box deal, a routine payment that nobody thought to list as permitted leakage.

None of these are sharp practice. They are the consequence of terms drafted by one side and accepted by the other without testing what they do across a full trading cycle.

What can a seller do about it?

Understand your own cycle before anyone asks. Know how your working capital moves through the year and why. If you cannot explain the pattern, you cannot argue about the target.

Clean up before you go to market. Collect what is collectable, deal with the balances that are not, and value stock on a basis you can defend. This takes time and cannot be done during a transaction.

Keep reporting that stands up. A buyer's adviser will test the numbers against the underlying records, and a locked box depends on them. Weak reporting hands the buyer the argument. Our guide to due diligence when selling a business covers what they will ask for.

Get the definition looked at, not just the target. Which balances are included matters as much as the number itself, and the definition is where value quietly moves.

Take advice before you agree heads of terms. The mechanism is usually settled at that stage and treated as fixed afterwards, even though it is rarely discussed as carefully as the price.

The underlying position also feeds the valuation itself, since a business that consumes working capital as it grows is a different proposition from one that generates cash. Our business valuation services set out how that assessment works.

How does this fit into preparing for sale?

It is one of the areas where preparation converts directly into money kept, and one of the few where the work is unglamorous and entirely within your control.

Tightening credit control, resolving old balances and reporting on the position regularly are all things a business benefits from whether or not it ever sells. They also happen to be exactly what removes the buyer's easiest arguments. Our business advisory service works on this with owners well ahead of a transaction.

For a view of where your business currently stands across the areas that decide a sale, the Exit Readiness Scorecard works through them. For the wider process, see our guide to business exit planning, or speak to our team about your own position.

Frequently asked questions

What is working capital in a business sale?

Working capital is the money tied up in day to day trading, principally stock, amounts owed by customers and amounts owed to suppliers. In a sale it is treated separately from the headline price, because the buyer expects to receive a business carrying enough of it to continue trading normally without injecting funds immediately after completion.

What is a working capital adjustment?

A mechanism that compares the working capital present in the business at completion against an agreed target, and adjusts the price by the difference. Deliver more than the target and the consideration increases. Deliver less and it reduces. It is standard in company sales and it is negotiated rather than calculated by a fixed rule.

How is the working capital target set?

By reference to the trading history of the business, usually by averaging the position across a period both sides accept as representative. The difficulty is that most businesses fluctuate through the year, so which period is chosen, and which items are stripped out as unusual, materially changes the outcome. It is a negotiation informed by evidence rather than an objective figure.

What is the difference between completion accounts and a locked box?

Completion accounts measure the actual position on the day of completion and settle the price afterwards, which is accurate but means the final figure is unknown at signing. A locked box fixes the position at an earlier date that both parties have already reviewed, so the price is certain at signing, with the seller undertaking not to extract value in the intervening period.

What is leakage in a locked box deal?

Leakage is value leaving the company for the benefit of the seller between the locked box date and completion, such as dividends, unusual bonuses or payments to connected parties. It is prohibited unless it has been agreed in advance as permitted leakage, and the seller normally has to repay any leakage that was not permitted.

Is a locked box or completion accounts better for a seller?

Neither is better in every case. A locked box gives certainty of price and a cleaner exit, but it depends on accounts at the locked box date that a buyer is prepared to rely on. Completion accounts can suit a business whose position changes quickly, but they leave the final figure open until after you have handed over control.

Can the working capital adjustment reduce what I receive?

Yes, and it commonly does. If the business holds less working capital at completion than the agreed target, the consideration reduces by the shortfall. Because the calculation often happens after completion, sellers can find the final amount lower than the figure they agreed without having done anything wrong.

Should I collect outstanding debts before a sale?

Yes, and well in advance. Aged balances that will not be collected are usually excluded by the buyer at completion, which reduces the working capital delivered and therefore the price. Resolving them early means you either recover the money or stop carrying it as an asset you will not be paid for.

When is the working capital mechanism agreed?

Normally at heads of terms, before detailed negotiation begins, and it is treated as settled from that point. That is earlier than most sellers expect, and it is the reason advice taken at the offer stage is worth considerably more than advice taken once lawyers are drafting.