Understanding Debt-Free, Cash-Free Adjustments When Selling a Business

In the process of selling a business, a lot of attention goes toward maximizing the company’s value, often calculated on an Enterprise Value basis. Enterprise Value typically involves multiplying a profit metric, such as adjusted EBITDA, by a multiple, yielding a consistent valuation that can be used across different businesses. This value, however, doesn’t consider specific funding structures or cash balances unique to each business.

To determine the Equity Value, which is what shareholders actually receive, adjustments are made for cash and debt. These adjustments can involve extensive discussions and potential disagreements, as they are open to interpretation.

For those thinking about selling, understanding these adjustments in the context of their business is crucial. Being realistic about the debt-free/cash-free adjustments helps facilitate a successful transaction. Strategic planning in this area can also positively influence the final proceeds for the seller.

Key Principles of Debt-Free, Cash-Free Adjustments

Buyers generally expect to acquire a company without structural debt and with only enough cash to handle its routine working capital needs. Debts that the seller typically covers include bank loans, overdrafts, invoice financing, shareholder or director loans, intercompany balances, hire purchase agreements, and any corporation tax due up to the transaction date.

Other items, depending on the specifics of the deal, might also be considered debt. These can include deferred income (if services or goods are still owed), lease dilapidation costs, deferred tax liabilities, accrued bonuses, or fees related to breaking financing arrangements.

To calculate how much cash should stay in the business, buyers often review at least a year’s history of cash requirements to gauge the highest seasonal needs and peak balances within each month. They aim to avoid having to add more cash for normal operations post-sale, so they might also examine short-term cash forecasts. Based on these insights, buyers will set a target level for working capital, typically covering trade payables, receivables, and inventory. If working capital is below the target at completion, an additional cash adjustment might be needed.

Where there is a shortfall in cash needed to meet these targets, it may reduce the final deal value. Conversely, if the business has more cash than needed, that surplus might be added to the purchase price.

Potential Areas of Debate in Adjustments

While the concept seems straightforward, various aspects often spark extensive negotiations:

1. Deferred Income – If no future costs are needed to fulfill the obligation, should this still be classified as debt?

2. Deferred Tax – If no tax liability is likely to arise, is it fair to consider this as debt?
   

3. Lease or HP Debts – In asset-heavy companies, these debts relate directly to specific assets that aren’t separately valued. Is deducting them fair?
   

4. Lease Dilapidations – How should dilapidations be accounted for if the company is only partway through a lease?
   

5. Changes in Trading Patterns – If business patterns have shifted, should past peaks in working capital be a factor?
   

6. R&D Tax Credits – Should potential credits be included when calculating net corporation tax?
   

As each of these considerations is negotiated, the gap between the seller’s and buyer’s views on a fair adjustment can be significant, even with both sides acting in good faith.

Strategies for Sellers to Optimize Debt-Free, Cash-Free Adjustments

To avoid unexpected issues with adjustments, sellers can take proactive steps:

1. Understand the Calculations – Be clear on all components of the adjustment and consider both best and worst-case outcomes.
   

2. Prepare for Buyer Expectations – Recognize that buyers want a business that doesn’t need an immediate cash infusion post-sale. Tracking deferred revenue against future obligations can help substantiate this.
   

3. Manage Working Capital Efficiently – Maintaining efficient working capital practices in the years leading up to the sale can reduce the cash requirement at sale. Spreading regular payments throughout the month can also reduce peak cash needs.
   

4. Support Tax Adjustments – Gather evidence to support any mitigating factors, particularly with tax payments, if moving from annual to quarterly schedules or other structural changes.
   

In conclusion, sellers should pay close attention to the debt-free, cash-free adjustment process. Like focusing on EBITDA and maximizing multiples, being well-informed, using evidence to support calculations, and presenting clear arguments backed by data can lead to a favorable outcome.

At a minimum, sellers should understand the potential impact of these adjustments and be prepared for the negotiations that can arise.

If you’re considering selling your business, I’d love to learn more about you, your business, and what you would like to achieve from your exit. During our call, I can provide you with a complimentary valuation and exit strategy insight.

I’m currently looking to acquire a business that meets specific criteria. However, if your business isn’t the right fit, I can still help by connecting you with a trusted broker that best matches your needs, drawing from my network of top UK brokerages.

Please note: I do receive a commission from brokerages when a sale closes, but I only recommend brokers with the most suitable buyer pool to maximize the chances of selling your unique business.

Additionally, I offer a "find a buyer" service, all at no up-front cost to you.

If you're exploring an exit, schedule a no-obligation call below, and let’s work on an exit plan together.

How can I help you?