Pricing plays an important role in acquisitions. That price often depends on the future earning capacity of the company and is usually expressed as a multiple. For example, a factor x the profit, revenue or EBITDA.
Yet that is often just a base price. After all, it assumes a cash and debt free approach. But what does cash and debt free mean in acquisitions? And how do you avoid discussions about those terms?
Free of debt and cash
Literally, cash and debt free in acquisitions means that the company is free of cash (cash) and debt (debt). In practice, many companies do have some cash and debt position as of the acquisition date. This means that cash and/or debt must still be factored in when determining the price for the shares. The cash and debt free price acts as the basis for this. Add the available cash, subtract the debt and the result is the final acquisition price.
Cash and debt free in acquisitions
It seems like a very simple calculation. Yet it often leads to discussions in acquisitions. Simply because different definitions are used for the terms. These discussions can significantly affect the acquisition price. So find answers to the question: what is cash and what is debt? Cash is often linked to excess cash and debt to interest-bearing debts. So, in principle, regular working capital is not included. But more factors come into play. With a number of examples we show that the interpretation is not always unambiguous.
Find answers to the question: what is cash and what is debt?
Practical examples
Example 1:
A company has a positive cash balance of €1 million on acquisition date. At the same time, a large item of pre-invoiced amounts creates a negative working capital. Is that € 1 million surplus? Or is it in fact a buffer?
Example 2:
A company has a positive cash balance of € 1 million on the acquisition date (January 1). The business has a strong seasonal pattern. Towards the summer a financing requirement arises through advance orders. Towards the end of the year this need decreases. In January it is therefore foreseeable that, despite the well-filled bank account, on June 30 there will be a financing requirement of € 4 mio. Regardless of whether there is financing facility for the peak need, is there any excess cash position as of January 1?
Example 3:
On the takeover date, a company has a positive cash balance of € 1 million and no interest-bearing debts. However, there is a considerable creditor balance due to past due accounts payable of more than 90 days. The buyer always pays bills on time, within a maximum of 60 days. Should the creditor balance in this case still be classified as debt?
These are just a few examples that show that cash and debt are not always unambiguous concepts. Cash and debt free is also often linked to "normal" net working capital. But what is it? Sometimes debt-like items, which strictly speaking are not interest-bearing debts, are still classified as debt. All this is food for thought, the outcome of which often has a substantial impact on the acquisition price.
Advice for buyers and sellers
Our advice to sellers: go into negotiations adequately prepared. Bring in your own analyses, maintain control in the dialogue with the potential buyer. And set the stakes early in the acquisition process. In this way, you significantly narrow the bandwidth of the numerical elaboration of the terms.
Our advice to buyers is the other way around: build in enough room at the front end of the process to ensure, based on the results of the due diligence, an appropriate translation into a final acquisition price.
