A working capital adjustment ensures that the seller delivers the business with a normalized level of working capital — typically calculated as current assets minus current liabilities. The parties establish a target working capital amount at signing, measure the actual working capital at closing, and adjust the purchase price up or down based on the difference. This prevents sellers from drawing down cash or increasing payables before closing to inflate the acquisition proceeds.
The standard working capital adjustment compares the target company's net working capital, defined as current assets minus current liabilities with specified inclusions and exclusions, at a measurement point near closing to a mutually agreed target or peg amount. If actual net working capital exceeds the target, the purchase price increases by the difference. If actual net working capital falls below the target, the purchase price decreases. The target is typically set at the average monthly net working capital over the trailing 12 months, normalized for seasonal fluctuations and non-recurring items. In Gurpreet Bal's experience, the working capital target negotiation is where many M&A disputes originate because the definitional choices in what constitutes working capital directly affect the purchase price.
A locked box mechanism fixes the economic effective date at a historical balance sheet date, with any cash flows after that date belonging to the buyer through a price adjustment. A closing accounts mechanism calculates working capital as of the actual closing date, with the parties preparing and potentially disputing the final closing balance sheet post-transaction. Locked box mechanisms are faster and more certain; closing accounts mechanisms reflect the actual economic position at closing.
The closing accounts method, described above, is the more common approach in US technology M&A. An alternative approach used primarily in European transactions and increasingly in certain US deals is the locked box mechanism, which fixes the economic split between buyer and seller at a reference date before closing and prohibits value leakage from the target between the reference date and closing. The locked box eliminates post-closing purchase price disputes but shifts the risk of working capital fluctuation between the reference date and closing to the buyer. Gurpreet S. Bal advises clients on which mechanism is appropriate based on the volatility of the target's working capital, the length of the signing-to-closing gap, and the parties' relative appetite for post-closing adjustment risk.
The definition of working capital — which line items are included, how specific accounts are calculated, and whether certain items are classified as debt rather than working capital — can move the effective purchase price by millions of dollars. Buyers and sellers often define working capital differently for the same business, and these definitional disputes are the most common source of post-closing purchase price adjustment litigation.
The most consequential negotiation in any working capital provision is the definition of net working capital itself. Key items subject to negotiation include whether cash and cash equivalents are included or excluded, how deferred revenue is treated, whether the definition includes accrued but unpaid transaction expenses, the treatment of intercompany balances, the classification of prepaid expenses, and the handling of income tax receivables and payables. Gurpreet Bal advises that each definitional choice can shift hundreds of thousands or millions of dollars in the effective purchase price and should be negotiated with the same rigor as the headline deal terms.
Most M&A agreements provide a dispute resolution process: the buyer prepares the closing balance sheet, the seller has a period to object, the parties negotiate, and unresolved disputes are submitted to an independent accounting firm acting as an expert (not an arbitrator). The accounting firm is bound by the agreement's definitions and principles, and its determination is typically final and binding. These proceedings are faster and cheaper than litigation but the outcomes are often unpredictable.
Purchase agreements typically provide that the buyer prepares a proposed closing working capital statement within 60 to 90 days after closing, the seller has a review period to object, the parties attempt to resolve disagreements through negotiation, and unresolved items are submitted to an independent accounting firm for final determination. The independent accountant's decision is binding on both parties. Key negotiation points include the selection methodology for the independent accountant, whether the accountant's determination is limited to the items in dispute or can address other aspects of the calculation, and whether the accountant is confined to choosing one party's position or can determine its own figure within the range defined by the parties' positions. Gurpreet S. Bal advises clients to negotiate these procedural details carefully because the dispute resolution framework often determines the outcome of working capital disagreements.
Gurpreet S. Bal is a Partner at Foley and Lardner LLP in Silicon Valley, where he advises startups, founders, and investors on mergers and acquisitions, venture financings, IPOs, and cross-border transactions. He has advised on more than 50 M&A transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology.