The Working Capital Trap: A Surprise Deal Killer in Private-Side M&A

Private-side M&A deals, while less costly than large public transactions, still carry significant expenses. I always advise my team and newcomers to M&A to factor deal costs—legal fees, accounting advisors, appraisals, due diligence, and labor—into the total purchase price and project ROI. These costs typically range from 4% to 10% of the deal value, a substantial figure that varies by transaction but cannot be ignored.

Throughout my career, I’ve worked to avoid “deal heat”—the urge to close a deal at the expense of overlooking critical issues. As a corporate strategic buyer, succumbing to deal heat risks eroding the transaction’s value. At times, maybe I have taken that too far, once walking away from a deal where the gap to close was small relative to the total value. In hindsight, I regret that decision. However, there are times when walking away is essential, even at the eleventh hour. One recurring issue that has forced me to abandon deals—sometimes just days before closing—is working capital manipulation. This post explores this often-overlooked deal killer.

The Importance of Working Capital

When I first engage with a seller, I emphasize sorting out working capital (WC) immediately: “Let’s define working capital in the Letter of Intent (LOI) and carry it into the Purchase and Sale Agreement (PSA).” My goal is to establish clarity when trust is highest. Sellers are often surprised that something they consider trivial in the deal context could derail months of hard work. While working capital is critical to operations, its significance in M&A is frequently underestimated—until it collapses a deal.

I’ve had two promising acquisitions fall apart in nearly identical fashion, both days from closing, due to working capital disputes. Recently, I discussed this with my friend Neil Gunn, a top advisor in the broker space. He emphasized his efforts to warn sellers against manipulating working capital to inflate the sale price, a tactic that often backfires.

What Is Working Capital?

In M&A, working capital represents a company’s short-term liquidity—cash, receivables, and inventory needed for daily operations, minus short-term obligations like payables and accrued expenses. The formula is straightforward:

Working Capital = Current Assets – Current Liabilities

(excluding cash, debt, and certain non-operating items)

Working capital ensures the business can operate post-closing without a cash infusion. For buyers, it’s a safeguard; for sellers, it’s a negotiation point. If not clearly defined, it becomes a common source of post-closing disputes and deal failures.

Two Cautionary Tales

Here are two examples of how working capital disputes derailed promising deals.

Deal One: An $800,000 Misstep

This deal was exhausting. We spent months on due diligence, ensuring a smooth post-closing integration. We devoted hours to employee benefits, addressing the seller’s concerns with creative solutions and incurring significant legal and consulting fees. Unlike many buyers who impose standard benefits, we went above and beyond to accommodate the seller’s requests for a seamless cultural and operational transition.

Early on, I urged our finance team and the seller’s CFO/COO to agree on a working capital target. I warned that WC could become a deal killer if mishandled. The seller proposed a target that seemed low compared to their historical operations. Our finance lead shared my concerns, suspecting the business required more working capital than claimed. Lacking full data early on, we trusted the seller’s figure—a mistake I take responsibility for, despite my finance team’s efforts.

As closing approached, we noticed concerning behavior: discussions about working capital were deflected in favor of 401(k) plans, bonuses, or benefits. We also suspected a key player on the sell-side lacked the same incentive to close as the owner. Ultimately, the actual working capital at closing was significantly higher than the agreed target—almost exactly where our finance lead had predicted. Per the PSA, this entitled the seller to an additional $800,000. They demanded payment; we refused. The deal collapsed.

While I could have paid the $800,000, the erosion of trust made post-closing collaboration untenable. Our relationship with the seller remains strained, and I can’t envision working with them again. The loss of time, money, and trust was entirely avoidable.

Deal Two: A $2 Million Surprise

In this case, the seller also pushed for a lower working capital target, citing “operational changes” that supposedly reduced WC needs. We challenged this but compromised to maintain momentum. As due diligence progressed, we noticed balance sheet inconsistencies but struggled to get clear answers. While we didn’t obsess over benefits as in the first deal, we still invested hundreds of thousands in due diligence and PSA preparation.

Working capital targets are typically set early, with updates closer to closing and a post-closing true-up. As we neared the finish line, the actual working capital aligned with our initial predictions, revealing a $2 million gap. The seller demanded the additional payment; we declined. Another deal fell apart at the last moment.

Why This Happens

Working capital disputes are among the most common deal killers in private-side M&A, particularly in late stages. Sellers view WC as a price adjustment mechanism, where a lower target increases the likelihood of a post-closing payment. Some attempt to game the system, undermining the true purpose of working capital: ensuring the business has enough liquidity to operate post-closing, like buying a car with a full tank of gas.

I value sell-side brokers, having completed many deals without them but recognizing their role in maintaining realistic WC targets. Brokers like Paul Wiltse and Neil Gunn at Venture North help prevent sellers from manipulating WC to inflate closing values.

Sellers may manipulate working capital in several ways:

1.  Cherry-Picking Periods: Selecting a low-WC month or seasonal dip instead of a historical average.

2.  Aggressive Payables/Receivables Management: Delaying vendor payments or accelerating collections to distort WC.

3.  Inventory Reduction: Cutting purchases before closing to temporarily lower WC needs.

4.  Reclassifying Items: Shifting liabilities or excluding assets from WC calculations.

5.  Point-in-Time Measurement: Using non-representative dates, like year-end, for WC snapshots.

6.  Projected Efficiencies: Claiming future process improvements will reduce WC needs.

How Buyers Can Protect Themselves

After these near-misses, I’ve adopted stricter practices:

•  Use a 12-Month Rolling Average: Neutralize seasonal swings or outliers by averaging WC over a year.

•  Define WC in the LOI: Establish the formula and intent early, not in the PSA. Clarify that WC ensures operational liquidity, as some sellers genuinely misunderstand its purpose.

•  Require Consistent Accounting: Ensure pre- and post-closing accounting aligns, especially for unaudited companies.

•  Monitor WC During Confirmatory Diligence: Track changes to catch last-minute manipulation.

•  Include Abnormal Event Adjustments: Build contract provisions to address unexpected WC fluctuations.

The Lesson

Trust is vital in M&A, but working capital is not the place for blind faith. Define targets early, back them with data, and recognize that every dollar conceded in the WC target may increase the purchase price at closing. Neither buyers nor sellers should let WC derail a deal.

Buyers: Never agree to a WC target without running the numbers yourself, even if it slows the proce