Summary
This document examines key issues encountered during the negotiation of cash-free, debt-free (CFDF) deals in M&A transactions. While CFDF terms are standard, the specifics are often not defined in initial agreements, requiring careful diligence and negotiation over what constitutes cash and debt-like items. The paper provides detailed considerations for both sides, emphasizing the importance of early identification and clear definition of CFDF items to avoid delays, disputes, or failed deals. Final pricing and settlement depend heavily on how these issues are resolved.
Action Items
- – Buyer & Seller Teams: Identify and review all relevant cash and debt-like items as early as possible in the due diligence process.
- – Legal/Deal Teams: Ensure specific CFDF definitions are incorporated into the purchase agreement, not just the LOI.
- – Finance/Accounting: Prepare detailed schedules distinguishing between cash, restricted cash, foreign cash, escrow, and other special items; and between interest-bearing debt and all debt-like liabilities.
- – Tax Advisors: Analyze and advise on treatment of accrued, deferred, and specific tax liabilities in the context of CFDF negotiations.
Rationale for Cash-Free, Debt-Free Deal Structures
- CFDF structures are standard due to valuation approaches that typically exclude cash and debt, focusing on EBITDA.
- The CFDF basis allows sellers to retain cash, with all debt repaid at closing.
- Since LOIs rarely define CFDF terms, detailed negotiation is needed during due diligence to clarify what constitutes cash and which liabilities are to be paid off or assumed.
Key Issues in Defining “Cash” in CFDF Deals
- Cash may appear differently in audited vs. internal statements, and may include or exclude outstanding checks, restricted cash, foreign cash, escrow, held checks, and credit card payments in transit.
- Outstanding checks: May be deducted from cash or treated as debt-like items.
- Restricted cash: Must consider if seller retains it or if buyer assumes obligations.
- Foreign cash: May trigger repatriation taxes; netting may be required.
- Escrow balances: Rights to amounts held in escrow must be clarified.
- Petty cash and in-transit payments: Small but require explicit allocation.
- Treatment of each type of cash item affects final price and closing mechanics and must be negotiated based on specific facts and accounting classifications.
Key Issues in Defining “Debt” and Debt-Like Items
- Interest-bearing debt (e.g., bank loans, credit lines, equipment leases) is straightforward, but many other liabilities—accrued bonuses, customer deposits, deferred revenue, affiliate payables, outstanding checks, accounts payable on extended terms—may also be considered debt-like.
- Accrued transaction fees, earnouts, pension obligations, unfunded or off-balance sheet items, and other unique liabilities may require bespoke treatment and negotiation.
- Tax liabilities (income, deferred, sales/use, unclaimed funds) are complex and must be separately addressed.
- Buyers generally seek to exclude or adjust purchase price for any liabilities that reduce effective value post-close.
The Final Settlement Mechanics
- Substantial adjustments to purchase price may occur based on definitions and negotiations regarding cash and debt/debt-like items.
- The purchase agreement’s definitions and schedules, not the LOI, are decisive if disputes arise.
- Early identification, detailed review, and explicit agreement on CFDF adjustment items enable smoother transactions and reduce risk of disagreement or deal failure.
Decisions
- Negotiate definitions of cash and debt on a deal-specific basis — Because no industry standard exists and each transaction’s facts vary, both parties should conduct detailed analysis and negotiate explicit definitions and adjustments for all relevant CFDF items.
Open Questions / Follow-Ups
- How should each unique or complex cash/debt item (e.g., restricted cash, affiliate payables, deferred taxes, foreign cash) be adequately addressed in specific deals?
- What are best practices for normalizing working capital levels for items that fluctuate, such as customer deposits and bonuses?
- Are there additional region-specific or industry-specific cash or debt-like items that should be considered in future deals?