Why almost all M&A Transactions are negotiated on Debt Free Cash 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.
  • Deferred Revenue
  • Warranty Claims
  • Accrued Bonus and Commissions
  • Restricted Cash and Outstanding Checks
  • Letter of Credit
  • Legal Settlements or Unusual Warranty Claims
  • Tax Liabilities
  • Earn outs and Deferred Considerations


  • 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.



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