Almost all M&A deals are negotiated on a cash-free, debt-free basis, but what does that mean? What happens to the existing cash and debt in the business being acquired?
Cash-free, debt-free by its simplest definition, means that when a buyer purchases a company and its assets, it is on the basis that the seller will pay off all debt and extract all cash before completion of the transaction.
What exactly is considered cash?
Cash held at a bank or on-hand is the most common cash type. Payments in transit, security deposits, short-term investments, and restricted or escrow cash may be considered cash equivalents.
What exactly is considered debt?
Most commonly, debt includes institutional loans, bank loans, shareholder loans, overdrafts, long-term debt, or unpaid dividends.
Other balances that buyers may argue should be considered debt-like include:
- Outstanding tax liabilities
- Accrued bonuses or commissions
- Other accrued expenses such as transaction fees, bonuses or holiday pay
- Gift cards
- Financial instruments (interest rate swaps or derivatives)
- Unusual warranty claims
- Deferred revenue
- Letters of credit
- Unfunded pension obligations
- Lease obligations
- Unusual provisions in employee contracts
- Previous acquisition earn-out or deferred consideration payments
- Litigation or other contingencies
- Any off-balance sheet liabilities
- Overdue accounts payable
- Deferred Capex, Capex backlog, or deferred maintenance
Common discussion items are deferred revenue, deferred income, or prepayments from customers. If the cash is already received and the service still needs to be performed, a Buyer considers this a debt-like item (or 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 services. However, if prepayments occur regularly, they could be considered part of normal recurring operations and part of working capital.
Accounts payable and accrued liabilities are not included in debt because they are part of working capital.
Why negotiate on a cash-free, debt-free basis?
Most M&A transactions are cash-free and debt-free (“CFDF”). CFDF means the seller takes all cash and repays all debt at the time of sale of the company. If you receive an offer for your business of $30 million on a cash-free, debt-free basis, this only means an investor values your business at $30 million or its enterprise value (“EV”). You derive the net purchase price by adding the cash and deducting any debt balances of your company to arrive at its equity value.
