If you ask an experienced M&A lawyer what causes the most post-closing disputes in transactions, the answer is almost always the same: working capital. Not valuation. Not representations and warranties. Working capital — specifically, the difference between what was agreed at signing and what was delivered at closing.

For founders who have not been through an M&A process before, working capital feels like a technical accounting concept that the lawyers and accountants will sort out. In reality, it is one of the most negotiated and most consequential financial elements of any deal.

WHAT IS WORKING CAPITAL IN AN M&A CONTEXT?

Working capital is defined as current assets minus current liabilities. In an M&A transaction, the parties agree to a target working capital level — the amount of working capital that should be in the business at closing to allow it to operate normally without requiring additional investment from the buyer.

The target is typically set based on a trailing average of historical working capital — often a twelve-month average calculated on a specific date or a rolling basis.

At closing, the actual working capital is measured and compared to the target. If actual working capital exceeds the target, the seller receives an upward adjustment to the purchase price. If actual working capital is below the target, the purchase price is reduced by the shortfall.

In a $20 million transaction with a $3 million working capital target, a $500,000 shortfall at closing reduces the seller's proceeds by $500,000. That is a significant number — and it is entirely within the seller's control if they understand the mechanics early enough.

WHY WORKING CAPITAL DISPUTES HAPPEN

The most common source of working capital disputes is definitional ambiguity. The purchase agreement specifies which items are included in working capital — and the definition matters enormously. Are deferred revenue balances included? What about accrued vacation liability? How are intercompany balances treated? What accounting policies govern the measurement?

When these questions are not answered precisely in the purchase agreement, each party applies their own interpretation at closing — and the interpretations frequently differ by hundreds of thousands or even millions of dollars.

The second most common source of disputes is timing manipulation. Sellers sometimes — intentionally or unintentionally — take actions in the period between signing and closing that increase working capital above sustainable levels: accelerating collections, delaying payments to suppliers, or building up inventory. Buyers protect against this through locked box mechanisms or specific covenants restricting changes to working capital management between signing and closing.

HOW TO PROTECT YOURSELF AS A SELLER

Understand the definition before you sign the term sheet. The working capital definition is frequently treated as a boilerplate issue at the term sheet stage and a significant negotiating issue at the definitive agreement stage. Agreeing in principle at the term sheet and fighting over the definition later is a recipe for disputes.

Model the working capital calculation yourself — in advance. Before entering any process, model your working capital on a monthly basis for the trailing twelve months. Understand the seasonality, the drivers, and the variability. Know what a reasonable target looks like before the buyer proposes one.

Negotiate the accounting policies explicitly. The purchase agreement should specify exactly which accounting policies govern the working capital calculation — the same policies as the historical financial statements, consistently applied. Any deviation should be explicitly agreed.

CROSS-BORDER COMPLICATIONS

In cross-border transactions, working capital is significantly more complex. Currency translation — how balances denominated in different currencies are converted for the working capital calculation — must be explicitly agreed. The locking date and the reference rate must be specified. In transactions where the business operates across multiple currencies, a small movement in exchange rates between signing and closing can have a material impact on the working capital calculation.

Different jurisdictions also have different norms for accounts receivable payment terms, supplier payment practices, and inventory management — all of which affect the appropriate level of working capital. A working capital target set based on US norms may be inappropriate for a business operating primarily in Brazil or the UAE.

CONCLUSION

Working capital is not a technical afterthought. It is a financial issue that deserves the same attention as valuation, deal structure, and earnout mechanics. Founders who understand the mechanics before entering a process consistently achieve cleaner closings and fewer post-closing disputes.

Panterra Finance advises on working capital mechanics and negotiation as part of every M&A mandate. Contact us at panterrafinance.com/contact for a free, confidential consultation.