Taking away the upside of a working capital adjustment is not protection for the buyer; it is an option the seller writes for free.
A two-way working capital adjustment moves the price up when closing working capital beats the peg and down when it falls short; a one-way adjustment only moves it down. The difference is worth the expected excess over the peg, which the seller gives up. On an illustrative peg of €20.0 million with a 40 per cent chance of closing above it, the one-way clause costs the seller €825,000 of expected price, 1.25 per cent of a €66.0 million equity value, before anyone has argued about a single balance.
Worked in full in Closing the Deal by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Buyers sometimes propose the one-way version as a protection against a business handed over short of working capital. It reads as reasonable: the buyer should not overpay. But a peg is an estimate of normal working capital, so on any given completion date the actual figure is as likely to land above it as below it. Removing the upside does not protect the buyer from overpaying; it transfers value from the seller.
| Input | Value |
|---|---|
| Enterprise value | 90.0 |
| Net debt at completion | 24.0 |
| Equity value before adjustment | 66.0 |
| Working capital peg | 20.0 |
Nobody knows the closing working capital at signing. The seller's finance team, looking at the seasonal pattern and the likely completion date, puts five outcomes on it:
| Closing working capital | Probability | Two-way adjustment | One-way adjustment | Price, two-way | Price, one-way |
|---|---|---|---|---|---|
| 17.0 | 10% | −3.00 | −3.00 | 63.00 | 63.00 |
| 18.5 | 20% | −1.50 | −1.50 | 64.50 | 64.50 |
| 20.0 | 30% | 0.00 | 0.00 | 66.00 | 66.00 |
| 21.5 | 25% | 1.50 | 0.00 | 67.50 | 66.00 |
| 23.0 | 15% | 3.00 | 0.00 | 69.00 | 66.00 |
The expected closing working capital is 20.225 million, so the peg is close to fair: slightly below the mean, which favours the seller under a two-way clause by €225,000.
E[adjustment] = Σ p × (NWC − peg)
= 0.10 × (−3.00) + 0.20 × (−1.50) + 0.30 × 0 + 0.25 × 1.50 + 0.15 × 3.00
= −0.300 − 0.300 + 0 + 0.375 + 0.450 = +0.225
E[adjustment] = Σ p × MIN(NWC − peg, 0) = −0.300 − 0.300 = −0.600
Value given up by the seller = Σ p × MAX(NWC − peg, 0) = 0.375 + 0.450 = 0.825
Excel, with outcomes in A2:A6, probabilities in B2:B6 and the peg in E1: =SUMPRODUCT(B2:B6,(A2:A6>E1)*(A2:A6-E1))
The check is that step 1 equals step 2 plus step 3: 0.225 = −0.600 + 0.825. A one-way clause is a two-way clause plus a free call option, written by the seller, on working capital above the peg.
Under the two-way clause the seller expects €66.225 million for the shares. Under the one-way clause it expects €65.40 million. The €825,000 gap is 0.92 per cent of enterprise value, and it rises with uncertainty: the wider the spread of possible closing balances, the more the option is worth, even with an unchanged peg.
If the seller accepts the one-way clause, it should ask for the headline price to rise by about €825,000 in exchange, or for the peg to fall. A risk-neutral seller is indifferent between the two-way clause at a €20.0 million peg and the one-way clause with the equity price raised by that amount.
| Peg | Two-way | One-way | Upside the seller gives up |
|---|---|---|---|
| 19.0 | 1.225 | −0.300 | 1.525 |
| 20.0 | 0.225 | −0.600 | 0.825 |
| 20.5 | −0.275 | −0.900 | 0.625 |
| 21.0 | −0.775 | −1.200 | 0.425 |
The lower the peg, the more a one-way clause costs the seller, because more of the outcomes sit above it. On a €19.0 million peg the option is worth €1,525,000. A peg at 21.0 million costs the seller less in option value, €425,000, but more in expected adjustment: the one-way expectation falls from −0.300 to −1.200 million. So a buyer who has won a one-way clause still has every reason to argue the peg up, and a seller who concedes one should hold the peg down. How the peg itself should be derived from monthly balances is in how to calculate a net working capital peg.
A seller is not entirely passive. In a cash-free, debt-free deal, cash at completion is paid for euro for euro, so a seller facing a one-way clause has every reason to collect receivables hard in the final weeks and turn working capital above the peg into cash it is paid for. If it can convert half of the expected excess this way, its loss falls to €412,500; if all of it, to nothing. The buyer then inherits a business with its receivables run down and its customers chased, which is not what either side wanted, and many buyers respond by adding conduct covenants for the period before completion. A two-way clause removes the incentive in the first place.
Judging the clause by the most likely outcome. At 20.0 million, the single most likely balance, the two clauses pay the same, so the one-way version can look harmless in a negotiation that discusses the base case only. The cost sits in the 40 per cent of cases above the peg, and only a probability-weighted view shows it. A collar, which ignores small differences in both directions, is a different trade and is priced in how a working capital collar works.
A one-way working capital adjustment is a two-way adjustment plus an option the seller gives away. Price it as the probability-weighted excess over the peg, €825,000 here, and either refuse it or charge for it in the headline price. The bridge from enterprise value to the price for the shares, with the adjustment as one line of it, is in the free workbook for this case.
It is a completion accounts mechanism in which the price falls euro for euro if closing working capital is below the peg but does not rise if it is above. In an illustrative deal with a €20.0 million peg, a closing balance of 18.5 million cuts the price by 1.50 million, while a closing balance of 21.5 million leaves it unchanged.
Only if it is paid for. The clause is worth the expected excess of working capital over the peg, which in the illustrative case is €825,000 on a €20.0 million peg. The seller can ask for the headline price to rise by about that amount, for the peg to fall, or for a two-way adjustment, which removes the incentive to strip working capital before completion.
List possible closing working capital balances with probabilities, then sum the probability times the amount above the peg. In Excel, SUMPRODUCT of probabilities and the positive excess does it. With five outcomes from 17.0 to 23.0 million around a 20.0 million peg, the two-way clause is worth +0.225 million to the seller, the one-way clause -0.600 million, a gap of 0.825 million.
This article is one calculation from Closing the Deal. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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