Before I get into it, one quick note.

Next month I'll be in Houston for the Rice University Texas ETA Conference on October 16. I'm on Panel 2, Diligence and Quality of Earnings, at 11:00 AM, and I'm moderating Panel 4, So You Bought a Business, Now What, at 3:10 PM. Andrea and Valerie from our team will be there too. If you're in the Houston area or thinking about attending and haven't locked in a ticket yet, reach out to me directly. With enough notice, I can probably get you a complimentary one. You can register here.

Now, onto working capital.

Disclosure: Priya and Marcus below are made up. I built them to show how differently a working capital peg gets calculated depending on what the business actually does, using the same diligence approach we run on real files.

Part 1: There is no Single Working Capital Number

On paper, net working capital is current assets minus current liabilities. Pull that straight off a balance sheet and you almost never get the number a buyer should actually negotiate around.

Two things happen before you get a real peg.

First, definitional adjustments. Strip out cash and cash equivalents, the current portion of long-term debt, and every non-trade current liability: payroll tax payable, sales tax payable, benefits payables, that kind of thing. What survives is the pure operating number: trade AR plus inventory minus trade AP. That's the figure a buyer actually has to keep funding after close on a cash-free, debt-free deal.

Second, method. Once you have that clean operating number, you still have to decide how to turn it into a peg: a trailing-12-month average of a single flat figure, or a cash conversion cycle build, days sales outstanding plus days inventory outstanding minus days payable outstanding, run against forward daily sales. These can land on meaningfully different numbers for the same business. Neither is automatically right. It depends on how stable the operating cycle is and how good the internal books are.

One more piece worth knowing on the financing side. The SBA 7(a) term loan itself can be sized to fund permanent working capital, separate from the purchase price. It shows up as its own line in sources and uses, not folded into the price.

Working capital is also getting more scrutiny from the SBA side than it used to. Under SOP 50 10 8.1, effective October 1, lenders are required to analyze working capital adequacy over at least the next 12 months as part of underwriting on these files, and if working capital eats up half or more of the loan proceeds, the lender has to explain in its own credit memo why that number is the right one. That's a real shift from a few years ago, when a lender might size the figure once at application and move on.

The new SOP also settled something that used to sit in a gray area. If the purchase agreement includes a working capital true-up and cash comes back to the buyer from the seller after closing, that money isn't treated as a seller rebate that has to pay down the acquisition loan.

The buyer can keep it to actually fund the working capital gap it was meant to cover. (SOP 50 10 8.1, Appendix 15, Change of Ownership Requirements, Item 21).

If you caught my piece on how QoE now works directly for the bank under the new SOP, this is the working capital half of that same story.

Part 2: Meet Priya and Marcus

Priya is buying Meridian Rehab Partners, an outpatient therapy and home health staffing company. Revenue is $6.0 million, adjusted EBITDA is $900,000, and the seller is asking $4.05 million, 4.5x. No inventory. The business bills insurers and Medicare, so cash always trails the work by weeks.

Marcus is buying Summit Package and Label, a commercial packaging and print shop. Revenue is $8.4 million, adjusted EBITDA is $1.05 million, asking price $4.725 million, also 4.5x. Same multiple as Priya's deal. Completely different working capital problem, because Marcus's business carries raw material and finished goods inventory.

Part 3: The Walkthrough

Priya's deal, receivables only

1. Strip the balance sheet. Exclude cash, a stale loan to a former business partner that's supposed to get settled before closing, a security deposit that hasn't moved in years, and deferred rent sitting flat on the books. What's left is trade AR against trade AP and accrued payroll.

2. Meridian doesn't track AR monthly, only at fiscal year end, so a trailing-12-month monthly average isn't reliable. Use fiscal year-end snapshots instead: $780,000, $1,050,000, and $820,000 across three years. The middle year is an outlier, a billing system migration caused a temporary backlog, not a real change in the business. Discard it, average the other two: $800,000 of AR, less about $150,000 of trade AP, lands the traditional method at roughly $650,000.

3. Now build it the other way. Meridian's collection cycle runs about 60 days from service to cash, and it pays its own bills in about 15. That's a 45-day cash conversion cycle, no inventory to add. Against $6.0 million in revenue, that's roughly $16,438 a day, so 45 days of that is about $740,000.

4. Traditional method says $650,000. The operating cycle method says $740,000, about 14% higher. That gap is the actual negotiation, not a rounding error. The operating cycle method is forward-looking. It's what Priya will actually need to keep the lights on at today's collection speed, not what the business happened to average historically.

5. Because this is a receivables-only business, the practical fix isn't more term loan, it's a revolving line of credit alongside the acquisition loan. A single slow-paying quarter from an insurer is a cash timing problem, not a permanent capital need.

Marcus's deal, inventory and receivables

1. Same strip: cash, current portion of debt, and non-trade current liabilities all come out. What's left is trade AR plus inventory minus trade AP, built monthly across 36 months because Summit's books actually support it.

2. The peg is the trailing-12-month average of that monthly recast figure: roughly $520,000 of AR, $340,000 of inventory, less $260,000 of AP, averaging out to about $600,000.

3. Here's the catch. Month to month, that recast number actually swings between $430,000 and $780,000 across the year, inventory builds ahead of a seasonal print run, then draws down. The flat $600,000 average sits right in the middle of that range, but it hides real intra-year swings of nearly $350,000.

4. Worse, the trend is moving the wrong way. Days inventory outstanding (DIO) has drifted from about 18 days two years ago to about 27 days on the current trailing-12-month view, while days payable (DPO) stayed flat around 20 days. The cash conversion cycle (CCC) lengthened from about 21 days to about 30 days, driven almost entirely by inventory sitting longer, not by anything happening in receivables or payables.

5. Tie that to free cash flow: adjusted EBITDA minus the change in working capital minus capex. In a heavy inventory-build month, free cash flow can go negative even with a strong EBITDA month. That's the month a buyer without a revolver, or a lender who only looked at the flat average peg, gets surprised.

Part 4: What Priya and Marcus's deals teach

The method matters as much as the math. Priya's business doesn't have reliable monthly data, so year-end snapshots plus a forward-looking cash conversion cycle build fill the gap. Marcus's business has real monthly books, so a full 36-month recast and a trailing average makes sense, but only if someone is also watching the trend line, not just the level.

Definitional adjustments come first, always. Strip cash, debt, and non-trade current liabilities before anyone argues about method or price. A number pulled straight off a balance sheet is not what you're actually negotiating.

A two-way peg adjustment in the LOI protects both sides, but only if it's tied to a documented trailing average or a stated methodology, never to a snapshot a seller can manage into place right before closing.

Watch the trend on days inventory outstanding or days sales outstanding, not just the current level. A business that's quietly building inventory or slowing collections is asking the buyer to fund more working capital than a historical peg assumes, and that gap shows up as a cash surprise, not a P&L surprise.

Part 5: What lenders are telling us

I'm hearing the same shift from the lender side, not just reading it in the SOP text. A few things I've had credit teams say to me this year, no names, no deal specifics attached, because the point is the pattern, not any one file.

None of that is a bad thing for buyers who show up with real numbers. It's a bad thing for buyers who show up with a working capital figure nobody can defend.

Part 6: Before you sign the LOI

1. Get the balance sheet review from the QoE before you argue about price.

2. Ask whether AR and inventory are tracked monthly or only trued up periodically.

3. Where the data supports it, build both a trailing-average number and a cash conversion cycle number. Don't accept either one blind.

4. Check the trend on DSO, DIO, and DPO over two to three years, not just the most recent figure.

5. Decide term loan versus revolver based on whether the cash need is permanent or seasonal.

6. Tie any peg adjustment in the purchase agreement to a documented methodology, not a point-in-time balance.

Final thought: buyers lose more sleep over purchase price than over working capital, and it's usually the other way around that bites them. The price is a single negotiated number. Working capital is a live, moving target that keeps changing after you own the business, and the diligence work above is how you make sure you're not the one who gets surprised by it.

If you're working on an acquisition, or you're in the pre-LOI phase, you can book a short, informal call to meet our team and learn how we can help.

Thanks for reading!

If you're working on an acquisition, or are in the pre-LOI phases, you can book a short, informal call here to meet our team and learn how we can help you.

For pre-LOI buyers ready to explore opportunities: Schedule a meet & greet call​

Already have a deal under LOI and need financing help: Schedule an LOI consultation​

Independent sponsors on a non-SBA deal (pre-LOI): Schedule a financing call with Rafael​

Independent sponsors with a deal under LOI: Schedule an under-LOI call with Rafael​

Until next time,

Matthias Smith

President, Pioneer Capital Advisory

​www.pioneercapitaladvisory.com​
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Disclaimer: The information in this newsletter is for informational purposes only and should not be considered legal or financial advice. Business buyers are encouraged to consult with their legal counsel and accountant to ensure the proper structuring of their transactions and to fully understand the tax implications of seller financing.

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