GLOSSARY
What Is Working Capital? | Agency M&A Definition
Working capital is the difference between a company’s current assets (cash, accounts receivable, prepaid expenses) and current liabilities (accounts payable, accrued expenses, deferred revenue). It represents the short-term liquidity the business needs to fund day-to-day operations. In agency M&A, the agreed-upon working capital level at closing determines whether the buyer or seller owes an adjustment after the deal closes.
Working Capital in Agency M&A
Working capital is one of the most frequently misunderstood and contentious elements in agency transactions. Most marketing agencies operate with relatively thin working capital because they are service businesses — there is no inventory to finance and capital expenditures are minimal. However, the timing mismatches between when agencies pay their people (biweekly or monthly) and when clients pay invoices (often net-30 or net-60) create real working capital requirements.
Buyers evaluating a creative agency will typically calculate a normalized working capital target based on a trailing 12-month average, excluding unusual spikes or dips. The purchase agreement then requires the seller to deliver the business at closing with working capital at or near this target. If the actual working capital at closing falls below the target, the purchase price is reduced dollar-for-dollar. If it exceeds the target, the seller receives additional payment. This mechanism prevents sellers from stripping cash, collecting receivables early, or delaying vendor payments to inflate the closing bank balance. Agencies with large retainer pre-payments can see significant deferred revenue on their balance sheet, which counts as a current liability and reduces working capital — something sellers often overlook during negotiations.
How Working Capital Affects Agency Valuation
Working capital adjustments can shift the effective purchase price by $50K-$200K or more for agencies in the $1M-$5M revenue range. The negotiation centers on two questions: what is the normalized working capital target, and how are deviations handled? Sellers benefit from establishing a target that reflects seasonal lows (since they may sell during a strong cash period and keep the excess), while buyers push for a target based on annual averages. Agencies with long payment cycles — common when serving enterprise clients — carry higher receivables and therefore higher working capital requirements, which can create friction at closing. Properly understanding your working capital dynamics before going to market prevents last-minute surprises that can delay or jeopardize a deal.
Example
A PR agency agrees to a $1.8M sale. The parties set a normalized working capital target of $120K based on trailing averages. At closing, the agency has $210K in accounts receivable, $30K in prepaid expenses, $75K in accounts payable, and $85K in deferred revenue (retainer pre-payments from clients). Actual working capital is $210K + $30K – $75K – $85K = $80K. Because actual working capital ($80K) falls $40K below the $120K target, the purchase price is reduced by $40K to $1.76M. The seller is surprised — she had focused on the cash in the bank and missed the deferred revenue liability.
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