The enterprise value does not correspond to the final purchase price. We explain the background and show how the actual payout amount from the sale of the company can be optimized.
When selling a company, buyers and sellers almost always negotiate the so-called enterprise value (EV) – the value of the operating business. However, the payment is based on the so-called equity value, i.e., the amount that actually flows to the shareholders after deducting or adding debt, cash and cash equivalents, and changes in net working capital.
A key factor in these adjustments is net working capital (short-term net current assets). If it deviates from the “normal” level at the closing date, the purchase price is reduced or increased accordingly.
The aim of this article is to show in a practical and simplified way:
1. What role the equity bridge plays as a calculation bridge between enterprise value and equity value,
2. How a working capital reference value (often referred to as PEG) is determined, and
3. Which levers can be applied 12–18 months before the process in order to achieve a higher purchase price.
What is the equity bridge in the M&A process?
When buyers and sellers negotiate the value of a company during a transaction, they usually refer to the enterprise value (EV). However, it is only the equity bridge, which is calculated in detail later in the M&A process, that shows what the actual equity value will be in the end.
In transaction practice, there are three key items used to determine equity value:
Financial liabilities (net debt)
Anything that bears interest or is repayable: e.g., bank loans, lease liabilities, shareholder loans. Every euro of debt reduces the purchase price by the same amount.
Cash (net cash)
Cash on hand and freely available bank balances are added. They increase the purchase price on a one-to-one basis – but only if they are actually unencumbered. Existing restrictions, e.g., guarantees or factoring blocks, may mean that these amounts are not allocated to cash.
Shortfall/surplus Net working capital (working capital adjustment)
Deviation of working capital from the previously determined PEG value.
If the net working capital is below the PEG at closing, the price is reduced.
In practice, buyers and sellers often discuss the classification of individual items in an equity bridge—in particular, whether they should be treated as cash-like, debt-like, or part of working capital. While “cash-like” and “debt-like” items affect the purchase price in full on a one-to-one basis, working capital items only have an impact via their deviation from the PEG. In order to avoid any valuation disadvantages, it is crucial to understand the relevant balance sheet items in detail and to prepare appropriate arguments in advance.
What is (net) working capital?
(Net) working capital refers to short-term net current assets, i.e., simply put, inventories plus short-term receivables minus short-term liabilities.
In practice, the parties agree on a target working capital value, which is referred to as PEG in many term sheets. This serves as a reference point for the subsequent purchase price adjustment when the company is sold.
The PEG value is usually determined on the basis of a historical average – typically over a period of 6, 12, or 24 months prior to the reporting date. The exact length of the observation period depends on the stability of the business model and possible seasonal fluctuations in the underlying positions. The aim is to reflect a realistic, operationally justifiable level of net working capital that is free of one-off effects or atypical fluctuations.
If the actual working capital on the reporting date deviates from the PEG, a purchase price adjustment of the same amount applies. For example, if the net working capital is €300,000 higher than agreed, the purchase price is increased accordingly (see chart below); if it is lower, the price is reduced. The basic idea is that buyers should not assume any liquidity advantage or disadvantage that is not attributable to the operating business.
Correctly classifying seasonal and industry-specific fluctuations
When determining a working capital PEG, it is generally not sufficient to simply calculate the average of the last three or six months. In many industries, working capital is subject to significant seasonal or structural fluctuations that would distort such an average – with a noticeable impact on the purchase price.
In retail, for example, it is common practice to build up inventories significantly at the end of the year in order to serve the Christmas business. Inventory levels and thus working capital are significantly higher during these months than during the rest of the year – not because the business model changes, but because the business cycle requires it. Conversely, project-oriented service companies may see a sharp increase in receivables toward the end of the year when many services have been invoiced but not yet paid. Even in SaaS business models with annual advance invoicing, individual months can provide a distorted picture when large cash flows are posted selectively.
A reliable PEG value must take such recurring fluctuations into account and should not be based on an atypical period. Buyers will carefully examine whether the proposed target value appears realistic in a seasonal context—especially if the economic transition occurs in a month with extreme fluctuations.
The classification of seasonal effects also becomes more important if past years were marked by exceptional influences – such as supply bottlenecks, catch-up effects, or pandemic-related delays. In such cases, it makes sense not only to show quantitative values, but also to explain their context clearly.
What data buyers expect
Another decisive factor in deriving a sustainable working capital level (PEG) is the underlying data. It is not enough to simply present quarterly figures or year-end figures. Especially in business models with high operational volatility or seasonal fluctuations, monthly figures are essential for identifying anomalies and operational patterns. Buyers use this information not only to verify the plausibility of the PEG value, but also to assess the company’s operational control system and accounting quality.
It is also essential that the composition and accounting of the relevant items – such as inventories, current receivables, or liabilities – remain consistent throughout the entire period under review. Changes in accounting logic or reclassifications between items should be clearly identified and documented in a comprehensible manner. Otherwise, the impression is created that the PEG value has been deliberately influenced – which in turn raises doubts about the validity of the entire equity bridge.
When analyzing the figures, buyers not only check the arithmetic mean, but also question any upward or downward outliers in particular. If these cannot be explained by external events or internal special effects, the PEG could be conservatively adjusted downward. Sellers are therefore well advised to ensure transparency at an early stage and to establish a reliable working capital time series during the preparatory phase that is sound in terms of both calculation and content.
Targeted management of equity bridge and working capital
An often underestimated lever for optimizing the purchase price is the early management of cash, financial liabilities, and working capital. Although purely mechanical calculations apply at closing, the actual purchase price depends, for example, on the level of working capital at that point in time—compared to the agreed PEG. Those who begin to specifically influence these variables 12 to 18 months before the planned start of the process can realize financial advantages.
Working capital involves three operational levers: receivables, liabilities, and inventories. If, for example, payment terms for customers are consistently enforced, the amount of receivables decreases and cash is realized earlier. The earlier inflow of liquidity improves both the working capital position and the cash balance at closing.
It is important that these measures are not implemented at the end of the year or quarter, but over a sufficiently long period of time with a stable effect. Buyers quickly see through one-off interventions in the last few months before closing – and will neutralize them.
Conclusion: Actively influence the purchase price – through transparency and preparation
The equity bridge is more than just a mathematical derivation – it is at the heart of the economic logic behind the purchase price. Those who understand the underlying mechanisms and take early operational action on working capital, financial liabilities, and cash can strengthen their own position in the transaction process in the long term.
A high working capital value at closing only has a positive effect on the purchase price if it is operationally justified and historically plausible. Short-term special effects or tactical interventions are quickly recognized by buyers – and often lead to conservative adjustments.
On the other hand, those who start the process with a robust database, comprehensible explanations, and realistic target values create trust – and increase the likelihood that the purchase price will reflect the actual potential of the company.
About Quantum Partners
Quantum Partners is a corporate finance and M&A advisory firm specializing in software & business services, digital media & commerce, industrial technology, and cleantech & sustainability. From its office in Munich, Quantum Partners advises clients worldwide on the sale of companies, acquisitions, and financing.
Call us for a confidential discussion. We would be happy to talk to you about our approach, our industry expertise, and references for our work.
Dr. Andreas Brinkrolf
Managing Director
brinkrolf@quantum-partners.de
+49 89 414144 355
FAQ: Equity bridge and working capital in the M&A process
What is an equity bridge in a company sale?
The equity bridge is a mathematical transition from enterprise value (company value) to equity value (purchase price for the shareholders). It takes into account liquidity, debt, and deviation from the agreed working capital target value (PEG) in particular.
Why is working capital so important in determining the purchase price?
Working capital that is too high or too low on the reporting date can significantly influence the final purchase price. Buyers expect a “normal” level of working capital – deviations from this lead to purchase price adjustments.
What is meant by PEG in the context of M&A?
The PEG is a calculated average value that should approximate normal or sustainable net working capital. It is based on historical monthly values and serves as a reference for subsequent adjustments.
How can I optimize my working capital before selling a company?
There is potential for optimization in the areas of receivables, payables, and inventories. It is important to start implementation early (12–18 months in advance).
What happens if the working capital deviates from the target value at closing?
In this case, a purchase price adjustment mechanism usually comes into play. If the working capital is lower than the PEG, the purchase price is reduced accordingly – and vice versa.
