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Cash and debt

Cash- and debt-free basis

Most transactions and M&A deals are on a cash-free and debt-free basis. In short, this means the Seller receives all cash and repays all debt at the time of sale of the Company. If you receive an offer saying your business is worth $100m on a cash- and debt-free basis, this does not mean you eventually get $100m. It only means an investor values your business at $100m (so-called enterprise value). You need to add the cash and deduct any debt balances of your Company before you arrive at the net purchase price (so-called equity value). This goes further than just your reported cash- and debt-balances and also includes cash-like and debt-like items.

Cash like items

The idea behind adding cash balances to arrive at the equity value is that the cash is excess and freely available. Next to reported cash balances it is important to consider also cash-like items, any non-operational assets fall in this category as well.

Some examples of cash-like items or non-operational assets are:

  • Long-term loan receivables
  • Deposits (e.g., for rent)
  • Deferred tax asset

Restricted cash

The cash items are non-operational and can often be converted into cash quickly.  If certain cash items cannot be quickly converted to cash they are considered as restricted cash (and not considered as cash in the EV to equity bridge). For example, post-dated checks. While under accounting principles these can be recorded as cash, if the actual cash collection is not immediate a Buyer will consider these as receivables and part of net working capital.

Debt like items

All interest bearing debt falls under the definition of debt in a transaction. In addition, other non-operational items for which short-term money outflow is likely are considered debt-like.

Some examples of debt-like items are:

  • Corporate income tax payable (while recurring, this is seen as a Shareholder expense as the related cash profits are taken out by Seller at Closing)
  • Financial instruments (e.g., interest rate swap)
  • Lease obligations
  • Accrued interest
  • Related party balances or current accounts with Shareholders
  • Overdue payables (consider here what is the “normal” overdue amount, if you always pay after 60 days versus the term of 30 days it should be considered part of normal operations and not seen as financing)
  • Dividend payables
  • Severance payables
  • Transaction advisory payables (open payables related to your advisors in the contemplated transaction)
  • Deferred capex, capex backlog or maintenance underspending
  • Open payables from EBITDA adjustments
  • Pending claims

Similar as the EBITDA adjustments there are no strict rules what should be considered cash-like or debt-like. It is all based on argumentation and is specific for each situation.

Deferred revenue, deferred income and received prepayments from customers

Common discussion items are deferred revenue, deferred income or received prepayments from customers.  If the cash is already received and the service still needs to be performed a Buyer considers this to be a debt-like item (or as restricted cash). A Buyer does not want this cash to be taken out at Closing, leaving them with the responsibility post-acquisition for the delivery of goods or service. However, if prepayments occur on a recurring basis it could be considered part of normal recurring operations and considered part of net working capital.

Deferred revenue plays an important role in IT deals where software subscriptions are sold in advance (e.g., on a yearly basis). How to treat this item is deal specific and case-by-case different and potentially even require negotiations to find a middle way which is acceptable to all parties involved.

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