Working Capital Adjustments and Post-Closing Disputes

The working capital adjustment is one of the most universal features of private M&A - and one of the most-litigated. The disputes follow a recognizable pattern: the parties agreed at signing on a methodology that seemed clear; at closing, the buyer's calculation differs from the seller's by an amount that surprises both sides; and the dispute resolution provision either resolves the difference cleanly or, more often, opens a months-long fight that costs more than the disputed amount.

Most working capital disputes are not really about working capital. They are about the interaction between three drafting elements: the definition of working capital itself, the accounting principles that govern the calculation, and the dispute resolution mechanic. When any one of these is loose, the others compensate poorly.

The working capital definition is the first place to invest drafting attention. The definition should specify, line by line, which balance sheet accounts are included and which are excluded. Cash and cash equivalents are typically excluded (with treatment of restricted cash addressed expressly), as is debt and debt-like items, but the boundary cases - accrued bonuses, deferred revenue, customer deposits, certain reserves - deserve explicit treatment. The illustrative calculation attached as an exhibit, prepared from a recent month-end balance sheet, is the single most useful interpretive aid the parties can give themselves.

The accounting principles language is the second drafting element and the one most commonly under-specified. A reference to 'GAAP, consistently applied with the seller's historical practice' is a starting point that creates ambiguity in every meaningful dispute. The drafting team should add a hierarchy: first, the specific accounting policies listed on a schedule; second, the seller's historical practice as actually applied (with supporting evidence); third, GAAP. Disputes about which level of the hierarchy controls are common; disputes among the parties about what GAAP requires are far less common than the working capital dispute landscape would suggest.

The dispute resolution mechanic is the third element. The standard structure - buyer prepares a closing statement, seller has thirty days to dispute, disputed items are referred to an independent accounting firm - works in principle but routinely fails in practice. The thirty-day window often expires before the seller has access to the underlying records. The 'independent accounting firm' is sometimes named, sometimes not, and the scope of its engagement is sometimes specified, sometimes left to the firm's interpretation. The fee-shifting rule is sometimes drafted with bite, sometimes not.

The drafting fixes are well-known. The dispute window should begin when the seller has had a defined period of access to the underlying books and records, not when the closing statement is delivered. The independent accounting firm should be named at signing or selected through a defined mechanism, with explicit scope (computational disputes only, not interpretive disputes about the agreement itself). The fee-shifting rule should reflect the actual outcome of the dispute - typically by allocating fees in proportion to the deviation from each party's position - rather than imposing fees on the disputing party regardless of outcome.

Beyond the drafting, two structural choices reduce dispute risk. First, the use of a 'true target' working capital figure based on a defined methodology - typically a trailing-twelve-month average - produces fewer disputes than negotiated targets that the parties cannot subsequently reconstruct. Second, the use of a meaningful escrow specifically for the working capital adjustment, with clear release mechanics, gives the parties an economic anchor that aligns incentives toward resolution rather than toward maximizing claim size.

Working capital disputes are usually drafting disputes wearing accounting clothing. The dispute itself is rarely about an unprincipled position by either side; it is about the absence of clear contractual language to resolve a question the parties did not specifically address. Tighter drafting prevents most of them. The drafting cost is measured in hours; the cost of a contested adjustment is measured in months and millions.

What we are watching

We will return to this topic across the coming quarter. If you are actively negotiating a transaction where these issues are live, we'd welcome a confidential conversation.

Three takeaways

• The market is settling, but the diligence bar is rising.
• Preparation, not posture, is the source of speed.
• The right structure can move price more than another round of negotiation.