Why almost all M&A Transactions are negotiated on Debt Free Cash Free basis?

Ramkumar Raja Chidambaram
6 min readJun 12, 2019


When the buyer expresses an interest to buy the business of the seller then he expresses the interest towards the bid through Letter of Intent or Term Sheet.In most of the LOI or Term sheet the buyer includes the final purchase price which is based on Cash Free Debt free basis.

What is the significance of Cash Free Debt Free basis?

  • In an acquisition, the buyer would purchase the value of the business based on the future cash flows that the seller business would bring in addition to the synergies that buyer thinks he can gain from this acquisition.
  • All the outstanding and Cash that the seller has in its balance sheet prior to transaction will be retained by the seller.All the cash and debt obligations post transaction would be borne by the buyer.
  • In some cases the buyer does absorb the seller debt which will be factored in the final Purchase price.In this case there will be a difference in the Enterprise Value and Equity value.The Shareholders will receive the proceeds after debt is factored.
  • Another important condition that the buyer puts in the Term sheet is that the final purchase price is subjected to the business operating at normal working capital.This means that post transaction, when the buyer starts to operate the target business then he is not required to inject any additional funds towards working capital to continue operations.

Definition of Cash, Debt and Debt like items

  • To execute the transaction on Cash Free Debt Free basis, the buyer and seller need to come to an agreement on what constitutes cash and debt.For this, we need to look at the balance sheet of the target.
  • Cash and cash equivalents would be found in the Assets side of the Balance sheet.This cash might include the petty cash, outstanding checks, cash in foreign accounts which the seller need to incur a tax on repatriation.
  • All cash over and above what is needed by the buyer to carry operations can be taken by the seller.For instance in case of Customer Deposits and Deferred revenues, the seller would have accepted payment in advance from the Customer but has not yet provided the customer its services.In this case, the buyer would not agree that seller sweeps this cash as the buyer needs to incur costs to provide services post transaction.
  • All the liabilities in the seller balance sheet like short term debts and long term debts will be treated as debt.The seller needs to find what part of the total debt outstanding is remaining.The seller needs to close this outstanding debts before the closing of the deal. In many cases the seller needs to incur Loan break up fees to close all his debts earlier.Hence the seller can negotiate with the buyer to take over these debts and there will be a corresponding adjustment on basis of dollar to dollar in Final Purchase Price. The buyer would also be interested to take over the debts if the interest payments can provide tax savings on its revenues.

When to consider a Liability a debt like or Working Capital adjustments?

  • The buyer would want to consider every liability as debt like, while seller would want that to be a Working Capital adjustment.By assuming each liability as a debt like, the buyer can reduce the final purchase price on dollar to dollar basis.
  • The simple rule to consider if a liability be considered as debt like or Working Capital adjustment is to look if that liabilities contributes to the business operations. For instance trade Payables would be a working capital adjustment but funding underfunded pensions contributions by buyer on behalf of seller would be treated as debt like.
  • There will be more adjustments to decide on the Target Working Capital based on the seller business whether it is cyclical or not and on the timing of the deal.This is beyond the scope of this article.

Some of the areas where there would be negotiations between the buyer and seller would be on:

  • Deferred Revenue

The seller would want to take the cash paid by customer as advance for which it has to provide services for in future as a part of Cash Free Debt Free basis.The buyer would object to it as the buyer has to incur costs to provide services.Hence this excess cash would be included as Working Capital adjustment.

  • Warranty Claims

The seller needs to have a liability provisioned for any claims on its services by its customers.This amount needs to be provisioned as Current Liability by the seller as the buyer is not expected to fund these.

  • Accrued Bonus and Commissions

The bonus payments for employees are generally paid at the end of the year.Hence the accrued amount for Bonus for employees and Commissions earned by the sales people needs to be provisioned as liabilities in the balance sheet by the seller.The buyer shall not pay bonus payments as well as salary hike of seller employees, hence the seller needs to adjust this before closing of transaction.

  • Restricted Cash and Outstanding Checks

This is more applicable for acquisitions in ecommerce companies where the customer pays for the product in advance and the company then pays this amount to the seller after adjusting for its fee.This cash paid by the customer cannot be considered as free cash by the target company and are considered as payables.

In case of outstanding checks, the seller may have issued check to settle its outstanding payments to its creditors but the money would not have been transferred from the seller bank account to the creditor. The seller may claim to sweep this cash as part of cash free debt free basis.In that case the buyer shall consider this liability as debt like and will reduce the final purchase price dollar to dollar.

  • Letter of Credit

The buyer will consider the Letter of Credit as debt like item and will expect the seller to settle any outstanding payments that it owes to the bank or the customer. If not then the buyer shall adjust the purchase price accordingly.

  • Legal Settlements or Unusual Warranty Claims

In case of any Legal disputes that the seller is currently facing, it is recommended that the seller needs to settle the same prior closing.The buyer will consider the legal costs as debt like and will adjust purchase price according.

Any amount that the seller needs to pay as a result of the legal suit in future will be treated as contingent liability by the buyer and the buyer will be indemnified accordingly. The same applies to any unusual Warranty claims from the customer that are not provisioned as warranty liabilities by the seller and the buyer will consider this as debt like.

  • Tax Liabilities

If the transaction is structured as a Stock sale then the buyer takes all the tax liabilities of the seller in future.Hence the buyer would consider these tax liabilities as debt like and the final purchase price would adjusted on a dollar to dollar basis.

  • Earn outs and Deferred Considerations

If the seller has acquired any company recently then the earn outs and deferred considerations/retention payments needs to be paid by the seller subjected to the completion of milestones.This liability will be considered as a debt like by the buyer and final purchase price will be adjusted accordingly.


  • The negotiations on which Liabilities would be considered as debt or debt like or adjustments in the Working capital between the buyer and seller would decide the Final Purchase price.
  • During the completion of accounts, the seller balance sheet would be audited and any changes in the target working capital/debt in the balance sheet would have an effect on the final purchase price.
  • It is important to treat each deal as different and hence treatment of what constitutes a debt or debt like liability will be differ from deal to deal.



Ramkumar Raja Chidambaram

Experienced M&A, Corporate Development Professional with extensive VC/PE experience