Working capital is the most negotiated post-closing adjustment in Illinois business acquisitions -- and the most misunderstood by first-time buyers and sellers. Getting the calculation wrong can result in tens of thousands of dollars of unexpected payments after closing.
In almost every Illinois business acquisition that includes a working capital adjustment, both buyer and seller believe the concept is straightforward -- until they start arguing about what should be included in the calculation. Working capital disputes are among the most common sources of post-closing litigation in business acquisitions, and the disagreements often trace back to ambiguities in how the purchase agreement defined the working capital target and methodology.
What Is Working Capital and How Is the Target Amount Calculated
Working capital in the context of a business acquisition is typically defined as current assets minus current liabilities at the time of closing, calculated according to a specific methodology agreed upon in the purchase agreement. The working capital target (or "peg") is the amount of working capital the parties agree should be present at closing -- representing the normal, ongoing operating liquidity the business needs to function.
Standard Working Capital Components
| Current Assets Typically Included | Current Liabilities Typically Included |
|---|---|
| Accounts receivable (net of allowance) | Accounts payable |
| Inventory (net of obsolescence reserve) | Accrued expenses |
| Prepaid expenses (operating) | Deferred revenue (current portion) |
| Other current operating assets | Other current operating liabilities |
Note what is typically excluded: cash and debt (handled through the enterprise value to equity value bridge), income taxes payable/receivable, transaction-related expenses, and intercompany balances. These exclusions must be defined precisely in the purchase agreement -- not assumed.
How the Working Capital Peg Is Set
The peg is typically set based on the trailing 12-month average working capital, sometimes adjusted for known seasonal variations. The logic: the buyer expects to receive a business with "normal" operating liquidity -- not a business that has been stripped of cash or inflated with working capital through manipulation.
Post-Closing True-Up Mechanics
At closing, an estimated working capital amount is delivered. After closing (typically 60-90 days), the parties calculate the actual working capital as of the closing date and compare it to the peg. If actual working capital is below the peg, the seller pays the difference to the buyer. If above the peg, the buyer pays the difference to the seller. A materiality threshold (typically $25,000-$50,000) means no adjustment is made for small variations.
Peg Setting Disputes: Why Working Capital Is the Most Negotiated Post-Closing Item
The disputes arise because working capital involves accounting judgments that both parties can reasonably disagree about:
- Seller pre-closing manipulation: A seller who delays paying vendors or accelerates collections in the weeks before closing artificially increases working capital, resulting in a post-closing adjustment claim against the seller
- AR collectibility disputes: The buyer claims that aging receivables are uncollectible and should be reserved; the seller argues they are fully collectible based on customer relationships
- Inventory valuation disagreements: The buyer applies aggressive obsolescence reserves; the seller argues inventory is saleable
- Methodology ambiguities: Purchase agreements that say "consistent with GAAP" or "consistent with past practice" without specifics generate endless disputes
How to Protect Yourself as a Seller in Working Capital Negotiations
- Insist on a precisely defined working capital methodology in the LOI and purchase agreement -- not vague references to "GAAP"
- Agree on the peg based on trailing 12-month average, not a point-in-time estimate, to protect against seasonal fluctuations
- Define specific accounting policies for AR reserves, inventory reserves, and other contested items before signing
- Set a bilateral materiality threshold (typically $25,000-$75,000) below which no adjustment is made
- Establish an escrow for potential working capital adjustments rather than leaving yourself exposed to an uncapped post-closing payment obligation
- Include a clear dispute resolution mechanism: if the parties can't agree on the final working capital calculation, an independent accounting firm resolves the dispute on a binding basis
For more on post-closing deal structures, see our post-closing adjustments guide and working capital in M&A guide.
Real Case Examples of Working Capital Disputes in Illinois Business Sales
The Rockford Manufacturing Dispute
A manufacturing company sale in Rockford closed with a $4.5M purchase price and a $1.1M working capital target. Post-closing, the buyer claimed $380,000 of accounts receivable were more than 90 days past due and likely uncollectible -- not properly reserved in the closing calculation. The seller argued the receivables were from long-standing customers who typically paid slowly but reliably. The dispute required a third-party accounting arbitration, ultimately resulting in a $220,000 post-closing payment by the seller. The entire dispute could have been avoided with a specific AR aging reserve methodology in the purchase agreement.
The Chicago Distribution Company Case
A Chicago-area distribution company sale generated a post-closing working capital claim of $450,000 when the buyer's accountants discovered approximately $280,000 in inventory that the seller had included at cost but that was slow-moving and hadn't sold in 18+ months. The seller's position: "We've always carried this inventory at cost; it's a normal part of our stock." The buyer's position: "GAAP requires a reserve for excess and obsolete inventory." The purchase agreement had no specific inventory reserve methodology. Result: negotiated settlement at $180,000. Both parties left unhappy. The solution would have been to negotiate and define the inventory obsolescence reserve policy before signing.
Frequently Asked Questions: Working Capital in Illinois Business Acquisitions
Conclusion: Define Working Capital Precisely Before You Sign
Working capital disputes are almost entirely preventable through careful drafting. The purchase agreement must define the working capital calculation with specificity -- specific inclusions and exclusions, reserve methodologies, and a clear post-closing true-up procedure. General references to GAAP create disputes; specific accounting policies create clarity.
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