A NWC Adjustment is a mechanism used to make sure a business is delivered with an agreed level of working capital at closing. Net Working Capital generally equals specified current assets minus specified current liabilities. If Closing Working Capital exceeds the agreed target, the seller may receive an increase in proceeds. If it falls below the target, proceeds may decrease. This purchase price adjustment protects the buyer from acquiring a business that needs an immediate cash infusion because receivables, inventory, or other operating assets were depleted, or because unpaid operating liabilities were higher than expected at closing.
The NWC Peg is the target amount of working capital the seller is expected to deliver at closing. A common starting point is average monthly net working capital during the trailing 12 months, although seasonality, growth, unusual expenses, and changes in operations may require adjustments. The goal is to estimate the Normalized Working Capital needed to run the company after closing. During Financial Due Diligence, buyers and sellers often analyze historical balances and proposed adjustments closely. Because every dollar above or below the peg can affect proceeds, both the amount of the target and the method used to calculate it matter.
Working Capital commonly includes accounts receivable, inventory, prepaid operating expenses, accounts payable, and accrued operating expenses. The exact definition depends on the purchase agreement and the business. Cash is typically excluded because many transactions are structured on a cash-free, debt-free basis. Debt and debt-like items are also generally excluded and handled separately. Particular attention should be given to overdue receivables, obsolete inventory, old payables, unpaid expenses, and reserves. The parties should also agree on accounting methods and specific exclusions before closing. Clear definitions prevent the same item from being counted twice, omitted entirely, or treated differently by each side.
Because final financial information is rarely available on the closing date, the buyer or seller typically prepares an estimated working capital calculation before closing. After closing, a final calculation is prepared using actual closing-date balances. That amount is compared with the NWC Peg stated in the purchase agreement. If final working capital exceeds the agreed target, the seller may receive an additional payment. If it falls below the target, the buyer may receive a payment or recover the applicable amount from escrow, depending on the agreement. The purchase agreement typically sets the preparation and review periods, objection procedures, and process for resolving unresolved accounting disputes, often through an independent accounting firm.
Disputes often arise because the agreement does not clearly define working capital or because closing accounting differs from the methods used to establish the target. Common issues include unrecorded accruals, overdue receivables, obsolete inventory, aging payables, inconsistent reserves, and items classified differently as debt or working capital. Problems can also occur when one party applies new accounting judgments after closing. These issues are best addressed before signing by documenting inclusions, exclusions, accounting policies, adjustment thresholds, and sample calculations. Tax items such as Depreciation Recapture are generally separate from working capital and should not be mixed into the calculation without specific agreement.
Who prepares and who reviews the closing NWC calculation?
The purchase agreement determines responsibility. Often, the seller prepares an estimated calculation before closing and the buyer prepares the final post-closing calculation. The other party receives a defined review period and may object to specific items before the adjustment becomes final.
How long does a buyer have to dispute the NWC?
The purchase agreement sets the deadline. Review periods commonly run for several weeks after the closing calculation is delivered. Buyers and sellers should follow the exact notice requirements because failing to object within the stated period may cause the calculation to become final.
How does a NWC adjustment differ from an Earn-Out?
An NWC adjustment measures whether the agreed level of working capital was delivered at closing. An Earn-Out usually depends on future business performance after closing, such as revenue or EBITDA. One settles closing balance-sheet economics, while the other creates contingent future consideration.
What happens when a purchase agreement has no NWC peg?
Without a working capital target, there may be no contractual mechanism to adjust the purchase price for differences in operating working capital. That can leave the buyer exposed to a business delivered with less working capital than expected and increase dispute risk.
For more than four decades, Bennett Thrasher has provided businesses and individuals with strategic business guidance and solutions through professional tax, audit, advisory, and business process outsourcing services. Contact Vijay Vaswani, partner in Bennett Thrasher’s Mergers & Acquisitions Transaction Advisory practice, or call us at 770.396.2200.
Never miss an update. Sign up to receive our monthly newsletter to unlock our experts' insights.
Subscribe Now