Improving the M&A process and transaction performance
How corporate M&A teams are structuring working capital mechanisms
Foundations for Corporate M&A Teams
Structuring Working Capital Mechanisms
Working capital mechanisms are engineered to ensure the target business is delivered on Day 1 with an operational "full tank of gas".
For the buyer, working capital mechanisms prevent sellers from depleting cash just before close, for example, by accelerating accounts receivable collections and delaying vendor payables.
When negotiating these mechanisms, deal teams must make several key decisions.
- Establish a normalized working capital baseline
- Select the appropriate structural working capital mechanism
- Define balance sheet items to be included, excluded, or recharacterized
Setting the Working Capital Peg
The baseline working capital target ("Peg") is generally calculated to account for seasonal and cyclical fluctuations. Often a trailing 12-to-24-month look-back is used. Non-recurring and unusual items are typically excluded.
After closing, the actual working capital is calculated and compared to the Peg. In most cases, there is some variation.
If the variation reaches an established threshold, the purchase price is then increased or decreased on a dollar-for-dollar basis.
A calibrated Peg and effective working capital mechanism will establish precise boundaries, ensuring that any pre-closing asset depletion or liability inflation is corrected in the final price.
Standard Working Capital Diligence
The Quality of Earnings report can be used to assess historical balance sheets and adjust for unusual transactions and seasonal working capital peaks to support the working capital Peg.
This analysis can also provide visibility on deferred revenue, which can be treated as debt, working capital, or excluded entirely to prevent pre-closing cash-collection gamesmanship.
Financial diligence is also used to identify slow-moving, aging, or obsolete inventory that can be carved out from the Peg calculation.
Accelerated Working Capital Diligence
Some corporate M&A teams are using AI to quickly audit existing vendor and customer agreements to verify if payment terms (e.g., 60-day vs. 30-day AR/AP) are locked or manipulable by the seller.
In select transactions, with a compressed sign-to-close timeline, AI-accelerated diligence can be used to eliminate working capital adjustments entirely.
In that scenario, the parties rely strictly on cash-and-debt adjustments to simplify the closing working capital checklists.
Setting the Accounting Definitions
Working capital is one of the most disputed clauses in post-closing M&A transactions. The calculation methodology is often negotiated quickly and late in the process.
The members of the Institute have warned that relying solely on GAAP can lead to discrepancies and disputes, as accounting interpretations vary widely.
In-house counsel can provide guidance on standard approaches, i.e. ‘consistent with past practice’ and make sure GAAP is used strictly as a residual (backup) in the hierarchy for financial calculations.
The accounting and finance team is typically responsible for reviewing definitions for the working capital schedule. This will likely include current assets, accounts receivable, and inventory methods (e.g., FIFO, LIFO, weighted average), minus current liabilities like accounts payable and accrued expenses. This review will cover any items that should be excluded from the calculation, such as cash or debt.
Post-Close Working Capital Review
In most transactions a preliminary estimate is done pre-closing with a final true-up post-closing. In a small number of deals there is no adjustment.
Buyers typically have a quarter to deliver a post-closing statement. Then sellers have a month for their review.
It is not uncommon for the final true-up to be delivered late, in some cases more than 30 days.
Savvy M&A teams negotiate collars around the net working capital adjustment to help parties avoid prolonged, expensive disputes over immaterial balance sheet variances.
Collars establish a safe zone where minor fluctuations do not trigger a purchase price adjustment.
Working Capital Dispute Resolution
If the working capital is short of the Peg, funds can be drawn from a Purchase Price Adjustment escrow or a standard indemnity escrow.
According to the annual M&A Holdback study by J.P. Morgan Chase, Purchase Price Adjustments accounted for 43% of the escrow claims in 2025 (up from 41% in 2024 and 39% in 2023). They are generally resolved in less than 6 months.
In most cases, if there is an indemnity claim against the target, that amount may be able to be deducted from the earnout. That provision appears in four-in-five transactions involving a public buyer, according to SRS Acquiom’s Market Standard database.
Post-Close Purchase Price Adjustments
The definitive research on working capital mechanisms in acquisitions of high-growth targets, from SRS Acquiom, reports buyer claims at 50%, while surplus credits for sellers have appeared in 41% of the deals in their sample.
The average final adjustment amount for buyers has been 63% of the Purchase Price Adjustment escrow and 0.77% of the transaction value.
The best defense against a contentious post-close adjustment is early interdisciplinary alignment and a strong working capital mechanism.
Exclusively for Members of the Transaction Advisors Institute
Advanced Playbooks, Templates, and Negotiation Frameworks
on Working Capital Mechanisms
Available with an All Access Membership Account
FAQ on Working Capital Mechanisms
No. The post-closing working capital true-up is designed strictly to measure changes in the business’s operations between signing and closing.
It is not a backdoor to bypass agreed-upon indemnification caps or deductibles.
Corporate M&A teams should strictly segregate true-up mechanisms from representations and warranties. Substantive legal claims regarding historical accounting practices must be pursued exclusively through your indemnification channels.
As established in Chicago Bridge (Del. 2017) and Westmoreland (NY 2003), attempting to challenge a seller’s historical asset valuations as non-GAAP constitutes a claim for a breach of a financial representation, not a true-up calculation.
A generalized objection will result in a forfeited claim.
Do not submit a "placeholder" dispute notice expecting to flesh out the details during negotiations.
Ensure your accounting and legal teams have the resources immediately post-close to calculate precise disputed amounts and cite the exact contractual basis for the disagreement before the notice period expires.
Following Schillinger Genetics (Del. 2021), courts demand strict compliance with procedural requirements.
If your purchase agreement requires you to detail specific amounts and the basis for each disputed item, you must hit that exact level of granularity within the required timeframe.
Express GAAP requirements will override non-compliant past practices unless you draft otherwise.
Do not rely on boilerplate language.
Establish a clear hierarchy in the accounting principles section of the purchase agreement. If you intend to use the target's specific historical policies—even if they deviate from standard GAAP—explicitly state that in the event of a conflict, the historical policies shall prevail.
In Alliant Techsystems (Del. 2015), the court addressed the common, yet contradictory, standard of calculating working capital "in accordance with GAAP and consistent with past practices."
The court ruled that when a target’s historical past practices inherently violate GAAP, the express requirement to adhere to GAAP controls.
Their authority is strictly limited to verifying mathematical consistency, not adjudicating legal or overarching GAAP compliance.
When drafting the dispute resolution mechanics, explicitly define the scope of the independent accountant's role. Meticulously categorize potential dispute areas (e.g., complex tax interpretations or legal contract interpretations) and clearly state whether those specific issues are reserved for judicial determination or the accountant’s review. This prevents costly procedural battles over jurisdiction later.
Cases like OSI Systems (Del. 2006) and Penton Business Media (Del. 2020) have clearly defined the jurisdictional boundaries of accounting referees. They cannot evaluate overarching GAAP compliance, interpret complex tax laws, or adjudicate breaches of contract.
They act as "experts, not arbitrators."
Notable M&A litigation
on Working Capital Mechanisms
Schillinger Genetics, Inc. v. Benson Hill Seeds, Inc. (Delaware, 2021)
The Delaware Chancery Court emphasized the importance of strict compliance with procedural requirements in this case by ruling that the buyer was barred from claiming post-closing adjustments because it failed to deliver a compliant "Notice of Disagreement" detailing specific amounts and bases for each disputed item within the required timeframe.
Following Schillinger, corporate M&A teams are paying meticulous attention to procedural deadlines and content requirements for dispute notices, ensuring that any disagreement strictly adheres to the mandated granularity to avoid forfeiting adjustment claims.
Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC (Delaware, 2017)
The Delaware Supreme Court clarified the boundary between working capital adjustments and indemnification claims in this case by ruling that a buyer cannot use a true-up mechanism to allege historical GAAP non-compliance as a backdoor to bypass agreed-upon indemnification caps.
Following Chicago Bridge, corporate M&A teams are distinctly segregating post-closing true-ups—which strictly measure changes in the business between signing and closing—from representations and warranties, ensuring buyers cannot weaponize accounting referees to adjudicate breaches of contract.
OSI Systems, Inc. v. Instrumentarium Corp. (Delaware, 2006)
In this case the Chancery Court defined the jurisdictional limits of independent accounting referees in this case by ruling that their authority is confined to verifying whether a closing statement was calculated consistently with agreed historical methodologies, rather than evaluating overarching GAAP compliance.
Following OSI Systems, corporate M&A teams are precisely defining the scope of the independent accountant's role in purchase agreements, explicitly stating they act as an "expert, not an arbitrator" whose sole mandate is resolving technical math and consistency disputes.
Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P. (Delaware, 2015)
The Chancery Court in this case addressed the inherent conflict in requiring working capital to be calculated "in accordance with GAAP and consistent with past practices" in this case by ruling that when a target's historical past practices violate GAAP, the express requirement to adhere to GAAP controls.
Following Alliant, corporate M&A teams are avoiding this drafting trap by establishing a clear hierarchy in the accounting principles, often specifying that in the event of a conflict between GAAP and the target's historical policies, the specific historical policies shall prevail.
Westmoreland Coal Co. v. Entech, Inc. (New York, 2003)
The New York Court of Appeals established the state's definitive boundary for true-up disputes in this case by ruling that a buyer's attempt to challenge the seller's historical asset valuations as non-GAAP was fundamentally a claim for a breach of a financial representation, not a true-up calculation.
Following Westmoreland, corporate M&A teams governed by New York law are drafting exclusive remedy provisions with extreme care, ensuring that substantive legal claims regarding historical accounting practices must be pursued through indemnification channels rather than delegated to an independent accountant.
Penton Business Media Holdings, LLC v. Informa PLC (Delaware, 2020)
The Chancery Court further reinforced in this case the limits of alternative dispute resolution in M&A in this case by ruling that a disagreement over specific tax benefits arising in a post-closing adjustment fell beyond the narrow, explicitly delegated scope of the accounting referee.
Following Penton, corporate M&A teams are meticulously categorizing potential dispute areas—particularly complex tax or legal interpretations—to explicitly state whether they are reserved for the accountant's review or for judicial determination, thereby preventing costly procedural battles over jurisdiction.