Canada: Working Capital As A Purchase Price Adjustment Tool

Working capital adjustments were originally designed to ensure that enough cash remains in an acquired business to allow it to operate in the ordinary course post-closing without requiring a capital infusion by the new parent or shareholder(s), or to compensate the purchaser or vendor in the event that there is too little or too much cash, respectively, in comparison with what is needed to support the business' ordinary course operations. This is typically accomplished by specifying a working capital "peg" (an estimate calculated based on normalized historical averages) as of the closing date. Within a 60 or 90 day period after closing, the actual normalized working capital as of the closing date is calculated and compared against the peg, and the purchase price is typically adjusted up or down accordingly.

The way working capital adjustments are being used is changing, however. With a more competitive environment for transactions and with the speed at which letters of intent and term sheets are being negotiated for transactions, we have seen additional pressure on selecting a purchase price in advance of completion of due diligence or in setting a purchase price high enough in order to win in an auction or competitive bid situation. As a result, working capital adjustments may be used as a purchase price adjustment mechanism, and particularly with respect to issues which may arise in due diligence, after the target purchase price is set or once exclusivity has been negotiated.

As working capital adjustment provisions evolve beyond their traditional purpose, either intentionally or unintentionally, the risk of dispute also rises. This article summarizes some of the issues that may arise with working capital adjustments and some issues to consider while drafting to ensure more certainty in working capital adjustments.

Calculating the Peg

"Working capital" is defined as current assets less current liabilities. Current assets are those assets which are turned into cash within a period of a year, including cash and cash equivalents, inventories, accounts receivable and prepaid expenses. In most purchase transactions, cash is retained by the seller (and thus excluded from working capital) and prepaid expenses for such purposes are often limited to those prepaids that will provide a benefit to the buyer going forward. Current liabilities are those liabilities which are due within a year and would typically include short-term debt, accounts payable and accrued liabilities or "reserves". In a purchase and sale transaction it is often necessary to ensure that the items included in both current assets and current liabilities are consistent with the deal, as reflected in the other terms of the purchase agreement. For example, in an asset purchase transaction, if the buyer is not assuming accrued employment obligations at closing (such as accrued salary, vacation pay or sick days) such items should be excluded from current liabilities for working capital purposes, otherwise there is duplication. Similarly, in an asset purchase transaction, if the buyer is not assuming ongoing litigation costs, any accrual or reserve for such litigation should be excluded as a current liability.

At the time of negotiating the term sheet, parties may have very different ideas as to what the correct working capital number may be for the business to be acquired. Take an early stage business, for example. There, a purchaser may consider a more significant level of working capital to be necessary in order to transition the business to the next level, while the seller may have been operating the business with very little cash and engaging in such growth activities only when the excess cash was available. In such a case, is the "ordinary course" of the business a course of growth (with the regular investment that that entails) or a course of stability (with investment in growth being exceptional and reliant on funds outside the scope of "working capital")?

Another significant issue in calculating the peg is what should or should not be "normalized". Typically adjustments for normalizing working capital may be such things as head office charges where the company being sold is a subsidiary of a larger enterprise, and non-arm's length contracts or employment relationships. Many others are unique to each business, including accruals for liabilities, aged inventory or receivables, insurance premiums or other prepaid accounts, and matters disclosed in the agreement. Businesses with large cyclical changes to working capital, like retail businesses, may also require special mechanisms to address the period in which closing will occur, which may otherwise advantage or disadvantage the seller or purchaser. It is important to ensure that all of the definitions relating to working capital are tailored to the specific business being sold or purchased, to address the unique aspects of the business.

Consistency and the Reference Balance Sheet

There are a number of ways in which consistency can be an issue when dealing with working capital adjustments. First, and most importantly, the manner in which the peg is calculated must be consistent with the manner in which the actual working capital number is calculated. We often see a reference balance sheet included as a schedule to the working capital adjustment provision to help to ensure consistency in the approach. If a reference balance sheet is included, it is important that all line items over which an adjustment may be expected are included, even if such items have a zero balance at the time the peg is calculated. Second, should the balance sheet be consistent with GAAP and/or consistent with previous audited statements of the target company and which should trump? As wide variations can be found within GAAP compliant approaches, this question merits some consideration. Consider also the representations and warranties or indemnities surrounding GAAP compliance that may be applicable to your transaction and perhaps also to the reference balance sheet to ensure that there is no double counting or overlap.

The following cases are instructive:

Asset Classification

Without ensuring for consistency of the final working capital number with the peg, the accounting classification of an asset could be affected by intervening events, resulting in a different treatment in the reference balance sheet than applies in the final statement. An example of this can be found in Mehiel v. Solo Cup Company (2007 WL 901637 (Del. Super. Ct. May 26, 2007)), where the merger agreement had a post-closing adjustment for working capital, with an arbitrator to resolve disputes. At issue was a real property asset with a value of $5.6 million which had been treated as a current asset at the time of the negotiation of the peg, due to the fact that the facility was up for sale. The buyer argued that the facility should be a long-term asset and excluded from working capital. The arbitrator agreed that the asset was a long-term asset. The court refused to hear the case as it had been settled in arbitration. Therefore, the buyer received a $5.6 million reduction to the purchase price, and still kept the real property - a significant win. To avoid this type of result, it is important to ensure that the calculation of the estimated and actual working capital is based on consistent calculation metrics.

Double Recovery

In drafting a working capital provision, it is important not to draft in isolation but to consider the impact of the provision on the other provisions of the purchase agreement. Unintended double counting can otherwise result. In Brim Holding Company, Inc. v. Province Healthcare Company (2008 WL 2220683 (Tenn. Ct. App. May 28, 2008)), Brim Holding Company, Inc. acquired Brim Healthcare, Inc. from Province Healthcare Company. The seller agreed to indemnify the purchaser for a piece of outstanding litigation. The purchaser paid $50,000 to settle the litigation, and demanded that amount under the indemnity. However, the seller had included a $50,000 reserve in the balance sheet for the litigation and therefore defended the claim on the basis that the amount had already been covered. While agreeing that the seller's approach was logical, the court found that the documents supported the double recovery as the indemnity was drafted to cover all damages and not just for any amount not otherwise reserved.


There are more likely to be disputes around working capital adjustments where the adjustment is perceived to be used to alter the purchase price for matters which may have not been contemplated by one or both parties. Lack of certainty in the drafting and significant adjustment amounts may create the desire and opportunity for dispute. Many lessons may be learned with respect to disputes from the longstanding dispute detailed in Re Ivaco Inc. (2007), 86 O.R. (3d) 450 (S.C.J.), aff'd (2007), 87 O.R. (3d) 561 (C.A.). In September 2003, the Ivaco companies were granted protection under the Companies' Creditors Arrangement Act (Canada) and in December 2004, the businesses were sold to Heico pursuant to three asset purchase agreements, each of which contained a working capital adjustment. It would take almost three and half years to receive the disputed funds under the working capital adjustment, with Heico being ordered to pay $53 million. Most of the points at issue (and there were many) had to do with the process and procedural elements involved in the dispute, including (for example) whether or not the expert had the ability to make changes to both the final working capital number and the peg. The lessons learned from Ivaco include delegating procedural matters in conducting the dispute to the determination of the expert, in order to avoid a multitude of motions in court, as well as being careful to clearly limit the issues that may be subject to dispute.

Accountants as Experts vs. Arbitrators

Many working capital dispute mechanisms contemplate a third party expert to resolve any dispute that the parties are unable to resolve themselves. It may be important to consider whether you wish the expert to act as an expert or an arbitrator in resolving disputes. An arbitrator would typically ask for each side to present its arguments, and then select the winning argument. An expert would typically ask for each side to present its arguments, and then come to a conclusion which may accept some or all of the arguments of either party, with reliance also placed on his or her own expertise. Because parties presenting arguments tend (in our experience) to take a very one-sided approach, an expert's determination may be more equitable than a choice between two starkly opposing approaches, leaving more flexibility for a solution that reconciles the parties' respective positions.

Best Practices

Consider the following best practices when negotiating working capital adjustment provisions in M&A transactions:

  • Define all accounting terms that are used in the definition of working capital, taking care to ensure they are properly applicable to the business being bought or sold.
  • Include a reference balance sheet outlining the calculation and specifically identifying what is to be included and excluded, including zero balances for line items to be included but which may not be applicable in calculating the peg. Ensure the reference balance sheet is used to calculate both the peg and the final working capital number.
  • Consider whether or not the statement should be audited.
  • Consider whether GAAP should trump or consistency with prior statements should trump. Ensure that calculation of target or estimate and final working capital are consistent. Bear in mind that being GAAP compliant may not be specific enough in the context of the treatment of certain items.
  • Be mindful of the interplay between the working capital adjustment and other clauses in your agreement, ensuring (for example) that there is no double counting. If specific issues arise, a specific indemnity may be a better solution than including the matter as a working capital adjustment.
  • Draft the provision so as to limit the matters in dispute, and consider if the expert should have the authority to determine procedural matters with respect to the dispute.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.