Working capital: the quiet price term in industrial SME M&A
In a private-company acquisition the headline multiple is negotiated once; the working capital peg is negotiated twice — before signing, and again after closing. In an inventory-heavy manufacturer, that second negotiation is where several points of enterprise value quietly move.
The working capital peg is the target level of net working capital a buyer expects to find inside the business at closing. Actual NWC is trued up against it euro for euro, so the peg — not the multiple — decides the final cheque. More than 96% of private-target deals carry a working capital adjustment, and working capital is consistently the most frequent source of post-closing disputes. In a manufacturing business, inventory is the line where it is won or lost.
What is the peg, and why does it decide the real price?
Buyers acquire a business on a cash-free, debt-free basis with a "normal" level of working capital already inside it. Normal is defined by the peg: a target net working capital figure, usually a trailing 12-month average of receivables plus inventory minus payables. At closing, actual NWC is trued up against the peg euro for euro. Ten points above the peg is ten points of extra price to the seller; ten below is a deduction.
Two structural choices sit underneath it:
| Mechanism | How price is fixed | Where risk sits | Typical in |
|---|---|---|---|
| Completion accounts | Closing balance sheet prepared post-deal, then trued up | Buyer and seller share; disputes resolved later | Bilateral trade deals, US-influenced processes |
| Locked box | Price fixed on a historic balance sheet; leakage covenants protect the buyer | Seller carries the business from the locked-box date | Competitive European auctions, PE processes |
Neither is inherently better. A locked box gives price certainty and a clean exit, but only if the historic accounts are trustworthy — which is exactly what a quality of earnings review establishes. Completion accounts are more forgiving of a business with genuine seasonality, at the cost of a longer tail.
Why is inventory the hardest line in a manufacturing target?
Because in a materials business, inventory is not one number — it is three businesses at different stages, each with its own obsolescence profile. In tanning, for example:
- Wet blue / raw stock — commodity-like, priced by international hide markets, low obsolescence risk, high price volatility.
- Crust — tanned but unfinished. The highest optionality in the whole chain: it can still become almost any colour or article. Rarely obsolete, hard to value with a simple cost formula.
- Finished leather — colour-carded and article-specific. Tied to a season. This is the layer where a buyer will push for reserves.
A buyer's diligence team will typically test four things: ageing buckets (how much stock is over 12 and over 24 months old), the obsolescence reserve policy and whether it has been applied consistently, standard-cost-versus-actual variances, and whether physical counts reconcile to the ledger. Where a seller has never formalised a reserve policy, the buyer writes one — and it is always more conservative than the seller's.
What moves the peg in a seller's favour?
Not aggression. Documentation. Four things carry weight in practice:
- Seasonality mapped, not asserted. A collection business builds stock ahead of SS and FW deliveries. A 12-month average peg applied to a June closing punishes the seller mechanically. Show the monthly NWC curve for 24–36 months and argue for a seasonally adjusted or month-specific peg.
- A written obsolescence policy that predates the process. A reserve introduced during diligence looks like negotiation. One applied consistently for three years is accounting.
- Article-level traceability. Stock that can be traced to a hide origin, a tanning batch and an audited process is stock a buyer can resell. An LWG audit under the manufacturer standard, with verified traceability, supports the argument that finished inventory retains value rather than sitting as a write-down candidate.
- Clarity on what is not working capital. Customer tooling, sample libraries, colour cards and consignment stock at clients are routinely misclassified. Decide their treatment in the SPA definitions, not in the post-closing true-up.
The mirror of this is the buyer's own list — customer concentration, supplier dependency, capex deferral. We covered the first in customer concentration risk, and the strategic logic of buying upstream in vertical integration and acquiring material suppliers. How certifications themselves survive the transaction is a separate diligence question, covered in tannery certifications and change of control.
Does a multi-vertical platform change the calculation?
It does, in one specific way. A single-product manufacturer has a single seasonal inventory cycle, so its working capital swing is wide and predictable in the wrong direction. A platform serving several verticals — footwear, leather goods, premium bedding, hospitality packaging, marine interiors — has cycles that partially offset. Peak build for one line lands in the trough of another. The result is a flatter NWC curve, a narrower collar, and less argument at closing.
That is a diligence advantage as much as a commercial one, and it is one of the reasons buy-and-build acquirers look for multi-vertical manufacturing platforms rather than mono-product assets. Cross-border acquirers weigh it particularly heavily — see cross-border M&A in Spanish industrial SMEs. And how the inventory itself is financed day to day is a related but distinct question, covered in inventory and working capital in an industrial SME.
Frequently asked questions
What is a working capital collar?
A tolerance band around the peg — often ±2–5% of the target figure — inside which no payment is made either way. It removes arguments over immaterial amounts and is one of the cheapest terms to negotiate.
Should raw hide price volatility sit in the peg?
Usually not, if it can be isolated. Where commodity input prices swing materially between signing and closing, parties often carve the raw layer out of the adjustment or index it, rather than letting a hide market move rewrite the purchase price.
How far back should the peg average look?
Twelve months is the market default, but 24–36 months is more honest for a seasonal manufacturer. Bring the longer series yourself; a buyer will rarely offer it.
When should a seller start preparing working capital data?
Twelve to eighteen months before any process. Reserve policies, ageing reports and count discipline are only credible if they predate the transaction.
The open board. Looking for a manufacturing partner, a subcontractor or a materials platform for a new line? The TL San Martín Business Board — category Partners & factories — is a free, open B2B board for the leather and footwear industry. Post the capability you need, the volumes and the timeline, and let the industry answer.
TL San Martín is a third-generation Spanish tannery in Elda, Alicante, operating since 1995: LWG Gold audited under the manufacturer standard, solar-powered, with an in-house AI sourcing platform and a range spanning footwear, leather goods, premium bedding, hospitality and marine interiors. You can see how we work behind the material. The company maintains open conversations with partners and investors who share its view of industrial manufacturing. Confidential contact: jorge@tlsanmartin.com.