Within the acquisition of shares of a company, there are several fundamental aspects that need to be defined in order to achieve a clear equity transaction. One of these aspects is: what is the enterprise or equity value and how much will be paid?
Enterprise value
The price offered by the buying party is often based on the future cash flows (earning capacity) of the company in relation to the risk profile of these future cash flows. This can be calculated using several methods, such as the DCF and multiple method. The outcome of this is called the enterprise value.
In a bid, a purchase price is usually offered on an 'enterprise value' based on a cash and debt free position of the company. What does the term "cash and debt free position" mean for the final purchase price?
Simply explained, this means that the company's net debt position is offset against the purchase price. Or in other terms, that the company is delivered with a balance sheet cleaned of all assets and liabilities not related to realizing future cash flows and a balance sheet cleaned of (interest-bearing) liabilities.
While this line of thinking seems straightforward, defining the target terms can be a contentious negotiation point with the necessary impact on the transaction and associated pricing.
Points to consider
During the acquisition process, the 'cash & debt free calculation' is always a point of interest that is the subject of many discussions. Definitions and interpretations of parties may differ. The results of these discussions have a direct influence on the share price and/or acquisition price. It is essential to reach agreement on the definition and interpretation of cash and debt free at an early stage, so that not only is known what de ondernemingswaarde is, but also what a selling shareholder ultimately receives for his shares.
A number of important questions may arise during negotiations:
- Does one consider the entire cash or does one consider the excess cash? And then what is considered excess cash?
- What debts should be borne by the seller? Are these only interest-bearing debts or, for example, also taxes to be paid such as corporate income tax, and how do parties deal with provisions and reservations for staff vacations?
- How does one deal with volatile or volatile working capital? What is the usual/required working capital for the operations of the business to be acquired, and how will the parties determine this?
Answering the above company-specific questions requires sufficient financial and operational knowledge of the company and the market in which it operates.
Key negotiating points
To clarify the importance of cash and debt free in an equity transaction, we have written out a fictitious example situation. This is to provide a clear negotiation point for the adviser. The business to be acquired has a cash position of € 500,000 on the assets side of the balance sheet on the intended acquisition date. At the same time, the balance sheet shows a large item of pre-invoiced amounts in the form of work in progress. This leads to a negative working capital. In that case, should the €500,000 be considered surplus? Or is it instead a buffer needed for operations?
In a bid, a purchase price is usually offered on an 'enterprise value' based on a cash and debt free position of the company.
Ensure good substantiation
There is no clearly defined standard on how to deal with the various cash and debt items and their final settlement. This depends on the situation as well as the wishes and interpretations of both buyer and seller.
The definitions in the purchase agreement will ultimately give the final word. This agreement will show how cash and debt items are handled and their effect on the purchase price. Determining whether or not an item is within the net debt position requires strong arguments from the perspective of both seller and buyer.
These arguments should be analytically and negotiatively sound. The earlier these items are identified and discussed, the smoother the transaction will go. This is an important task for the adviser and his expertise in this field.
More information about cash and debt free? Also read our white paper where we elaborate on this term and also explain the application using concrete examples.
