The concept of 'Cash & Debt Free' is one of the most common terms used when negotiating a business transfer. But what exactly does the term mean?
Cash & Debt Free
Literally, 'Cash & Debt Free' means that the company is free of cash and debt. This means that on the economic acquisition date, the seller is entitled to the cash and cash equivalents present in the company as well as all debts are for the seller's account.
The available cash and debt are then added to or subtracted from de ondernemingswaarde in an 'off-balance sheet' manner to determine the final purchase price/equity value (the 'equity bridge'). Buyers often make an offer on the basis of 'Cash & Debt Free'; this means that the stated amount is (often) not actually received by the seller.
Determining equity bridge
In practice, the purchase price of shares is often determined based on the sum of:
- De ondernemingswaarde (based on the future operating earning capacity of the company);
- +/+ The cash on hand and 'cash-like items' (cash equivalents);
- -/- The outstanding debts as well as 'debt-like items';
- +/- Other adjustments agreed between the parties (for example, a surplus or deficit in working capital or non-operating assets).
If the balance sheet of the company being sold includes receivables from or payables to the shareholder, we always advise to state in the letter of intent the amount the seller will actually receive through the transaction. If there is a lot of cash present, then a pre-closing dividend can be used to 'lighten' the transaction.
Enterprise value
De ondernemingswaarde refers to the value of a company's future operations without regard to its financing structure. This is also called the operational value. There are several methods for calculating de ondernemingswaarde. Valuation methods based on cash flows and multiples are very common in M&A practice (also in SMEs!).
Valuation methods based on cash flows involve, for example, the 'Discounted Cash Flow' method and the 'Adjusted Present Value' method. In addition, when determining de ondernemingswaarde based on multiples, 'EBITDA multiples' and 'EBIT multiples' are commonly used. This is because EBITDA and EBIT are profitability indicators that are not influenced by the financing structure of a company and therefore very suitable for determining de ondernemingswaarde. Often the results of the aforementioned methods are compared ('sanity check').
Working capital surplus/deficit
At the economic acquisition date, there may be a so-called surplus or deficit in working capital. If there is a surplus or deficit in working capital, this results in a positive or negative adjustment to de ondernemingswaarde. The surplus or deficit in working capital is determined by comparing the available working capital at the economic acquisition date with the so-called 'normal' level of working capital.
In practice, the normal working capital level is calculated by assessing the average level of the various working capital positions over the past 12 months from the records.
Common point of discussion
During negotiations, discussions can arise between buyer and seller about the interpretation and application of the 'Cash & Debt Free' principle. The adjustments to be made for cash-like items and debt-like items as well as the deficit/surplus of working capital are, as part of the equity bridge, a common point of discussion during negotiations, partly due to the arbitrary nature of some items.
Therefore, it is important to be prepared for these discussions properly and timely, as such adjustments can have a substantial impact on the final purchase price to be received/paid.
Tip
We recommend that the 'Cash & Debt Free' calculation as well as the 'equity bridge' (pro forma) be worked out in detail and included in the letter of intent so that the parties have reached agreement on the main points of the transaction (including equity bridge). In this way, unexpected (detailed) discussions during the drafting of the final transaction documents are usually avoided.
