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In our last issue, we covered Quality of Earnings (QoE), including a Net Working Capital example. This issue dives deeper into working capital pegs and debt-like purchase price adjustments. What This Means: Net Working Capital (NWC) is a negotiated lever that directly influences purchase price through the working capital peg. The peg represents the normalized level of operating working capital a business needs, and is negotiated during the due diligence exercise using the most recent 12–24 months average to strip out seasonality and unusual items. Closing NWC is measured as of closing date using preliminary estimates, with final true-up adjustment 60-120 days post-close. In a cash‑free, debt‑free deal, NWC is usually defined as current assets (excluding cash) minus current liabilities (excluding debt and agreed debt‑like items), and deviations from the peg at closing drive dollar‑for‑dollar price adjustments.​ In summary, If closing NWC < peg, seller pays buyer (decreases purchase price). If closing NWC > peg, buyer pays seller (increases purchase price). The complexity lies in deciding what belongs in “operating” working capital versus what should be treated as debt‑like. Long‑dated or non‑operating obligations—such as environmental reserves, large warranty provisions, certain deferred revenue, or tax exposures—often behave more like debt in economic terms. If they remain inside working capital, they can distort the peg and blur accountability for future cash outflows; if reclassified as debt‑like, they reduce equity value or are settled by the seller outside the peg. Common Challenges: Real Deal Context: One of our clients acquired an industrial manufacturing company in a cash-free, debt-free transaction where the target carried historical environmental exposure and longer-term product warranties. During our due diligence, we identified sizeable environmental and warranty reserves in “accrued liabilities”—treated as current liabilities and included in historical NWC. Management noted these obligations would resolve over years but argued they were part of normal operations and embedded in historical financials. The buyer pushed to reclassify them as debt-like items for the EV-to-equity bridge. The parties agreed to: This preserved buyer protection and seller economics without renegotiating headline value. Suggested Success Factors: Share Your Perspectives: Have you encountered a situation where reclassifying an item between NWC and debt‑like materially changed the deal economics? How did you resolve it?

What This Means: Quality of Earnings (QoE) is a critical due diligence exercise that goes beyond the numbers in financial statements to assess the true, sustainable profitability of a business. Unlike a standard audit that verifies historical accuracy, a QoE analysis examines whether reported earnings reflect the ongoing operational reality and identifies adjustments needed for a normalized view of performance. QoE reports have become essential tools for buyers, lenders, and investors. They uncover accounting irregularities, one-time items, aggressive revenue recognition, and hidden risks that could materially impact valuation and deal structure. Common Challenges: Real Deal Context: We recently advised a private equity firm acquiring a Pennsylvania based Document Management Software company. The QoE exercise involved extensive negotiations around the Target Net Working Capital (NWC Peg), with particular focus on deferred revenue treatment. Our analysis examined the cost-to-serve existing customer contracts against collected revenues to ensure the negotiated peg would provide the buyer with adequate post-closing liquidity and operational flexibility. We continued our engagement post-close to validate the final working capital settlement against the target. The NWC Peg (Target Net Working Capital) is a negotiated benchmark—typically based on historical averages—that represents the expected working capital level a business needs to operate normally. At closing, the actual working capital is measured against this peg: if it’s lower, the buyer receives a dollar-for-dollar purchase price reduction; if higher, the buyer pays more. This mechanism protects buyers from inheriting a business that’s been stripped of operating cash while ensuring sellers aren’t penalized for maintaining healthy working capital levels. Suggested Success Factors: Informative Content: In a recent video podcast, I explored the nuances of Quality of Earnings, essential deal considerations, the evolving role of AI in deal execution, and more. Watch the full discussion here. Share Your Perspectives: Quality of Earnings analysis is the foundation of informed deal-making, protecting value and building trust between parties. Have you encountered significant QoE findings that reshaped a transaction? We would be interested to know how you addressed the issues and moved forward.

What This Means: “Deal jumping” occurs when a new bidder makes a competing offer after a deal is announced or signed, presenting a higher or better-structured proposal. This can force boards, sponsors, and strategic buyers to reassess the deal, their fiduciary duties, and protections in place. In mid-market deals, these situations are less common than in large-cap transactions, but they do happen — especially when deal protections are lighter, financing is accessible, and a competitor sees strategic opportunity. Common Challenges:  Real Deal Context: Occidental Petroleum vs. Chevron / Anadarko (2019): Suggested Success Factors: Share Your Perspectives: Deal jumping and topping bids are high-stakes maneuvers requiring strategy, foresight, and solid legal guidance. Have you been on either side of a topping bid? We would be interested to know how you navigated through the challenges?