Cash-free, debt-free means the price is set for the company as an operating whole, and the seller keeps any cash, pays off the company's debt out of the proceeds, and delivers a normal level of working capital. The buyer's lender then lends against a company with no borrowings ahead of it. The catch is the definition of debt. Finance leases, customer deposits, deferred revenue, accrued bonuses, unpaid taxes and transaction costs can each be called debt or left out, and every item left in the company at closing quietly adds to the leverage the buyer carries.
- Seller keeps
- Cash in the company at closing, unless the agreement says otherwise
- Seller pays off
- Funded debt and whatever else the purchase agreement defines as debt
- Seller delivers
- A normal level of working capital, measured against an agreed peg
- Where the fights are
- Debt-like items: leases, deposits, deferred revenue, accrued bonuses, taxes, transaction costs
- Why the lender cares
- Anything left in is a claim on the cash flow that services the new loan
The price is for the business, not the balance sheet
When a buyer offers a price for a company, the offer is usually built from earnings: a multiple of adjusted EBITDA. That number values the operating business. It says nothing about how much cash happens to be in the bank on closing day or how much the owners have borrowed. Cash-free, debt-free is the convention that separates the two. The headline price is the enterprise value; what the seller actually receives is that value, less the debt paid off at closing, adjusted up or down for working capital against a target.
Three moving parts follow. Cash stays with the seller, or is swept out before closing, because the buyer did not pay for it in the multiple. Debt is paid off from the purchase price, so the company arrives unencumbered. Working capital is delivered at a normal level, because the company needs receivables, inventory and payables in their usual proportions to produce the earnings the buyer paid for. That last part is the working capital peg, and it is inseparable from the debt definition: an item moved out of working capital and into debt, or the other way, changes the seller's proceeds.
In an asset purchase much of this happens automatically: the seller's entity keeps its bank account and its loans. In a stock purchase the purchase agreement has to spell it out, and the lender reads those clauses because they decide what the borrower owes on day one. See asset vs stock purchase financing.
A worked example
Take a company bought for a headline price of 10,000 (in thousands, say). At closing it has 600 of cash, a bank term loan with 1,500 outstanding, an equipment loan of 300, and working capital of 1,300 against an agreed peg of 1,500, both measured without deposits. It also holds 400 of customer deposits for work not yet started, and the draft agreement does not mention them.
| Step | Deposits left out of both debt and the peg | Deposits treated as debt |
|---|---|---|
| Headline price (enterprise value) | 10,000 | 10,000 |
| Less bank loan paid off at closing | (1,500) | (1,500) |
| Less equipment loan paid off | (300) | (300) |
| Less customer deposits | none | (400) |
| Working capital shortfall against peg | (200) | (200) |
| Cash kept by the seller | 600 kept | 600 kept |
| Seller's net proceeds from the price | 8,000 | 7,600 |
| Obligation left in the company for the buyer | 400 of work already paid for | 400 of work already paid for, but the price was cut to match |
In both columns the buyer's company must still do 400 of work for which the customers have already paid, and that cash has gone to the seller. If the deposits are treated as debt, the price falls by 400 and the buyer borrows less, or keeps the difference to fund the work. If the agreement is silent, the buyer pays full price and then funds those jobs from the company's cash, which in practice means the revolver or the term loan. Putting the deposits inside working capital, with a peg set to include them, reaches much the same result as the second column. The lender simply notices that in the first column the company carries 400 of obligations the financing model did not show.
What counts as debt: the items that get argued over
Bank loans, lines of credit, notes to shareholders and notes from the seller's own past acquisitions are debt by any definition. The arguments start further down the balance sheet. The purchase agreement's definition of indebtedness is where the buyer's side lists each item; anything not listed is, by default, left in the company or inside working capital.
| Item | Why buyers call it debt | What sellers argue | If it stays in the company |
|---|---|---|---|
| Finance leases on equipment | A fixed obligation to pay for an asset, just like an equipment loan | The payments are already part of running the business | The lender counts it in funded debt; it uses up leverage and coverage headroom |
| Earnouts and notes owed from the seller's earlier acquisitions | Deferred purchase price the company still has to pay | Rarely argued once found | A claim on cash that competes with the new loan; see paying off the seller's debt |
| Customer deposits and deferred revenue | Cash collected for work the buyer must now perform | A normal part of working capital, and in the peg | The buyer funds the work with borrowed cash |
| Accrued bonuses and commissions for the pre-closing period | Earned under the seller's ownership, paid under the buyer's | Routine accruals belong in working capital | An early cash outflow the model may not show |
| Change-of-control and transaction bonuses | Payments to staff triggered by the sale itself | Rarely argued; usually a seller cost | Paid by the company after closing unless the seller bears them |
| Unpaid pre-closing income taxes | The seller's liability for the seller's period | Rarely argued | In a stock deal, a claim the company must pay |
| Deferred payroll taxes, unpaid sales tax | Past-due obligations to taxing authorities, sometimes with liens | Timing differences | Tax authorities can take priority; lenders treat them as debt |
| Seller's unpaid deal costs, accrued interest, prepayment premiums | Part of the cost of selling and of retiring the seller's debt | Rarely argued | Paid at closing from somewhere; better from the seller's proceeds |
| Payables stretched well past normal terms | A hidden loan from suppliers | Payables are working capital | The buyer catches them up with its own cash after closing |
Why every item left in adds to the buyer's leverage
A lender sizes an acquisition loan against the company's cash flow and the obligations it can see: funded debt for leverage, scheduled payments for debt service coverage. Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA, and conventional bank lenders commonly look for debt service coverage of at least 1.25x. Those tests assume the balance sheet the model shows.
A finance lease left in the company is a second payment stream beside the new loan. Counted in funded debt, it puts leverage above plan and leaves a covenant set on the model's figures with less headroom from the first quarter. Customer deposits and deferred revenue do not show up in debt service at all, but they consume cash in the months after closing, which is exactly when a new owner has the least slack. Stretched payables do the same. None of these kill a deal on their own, but together they can turn a comfortable structure into a tight one.
The fix is not to call everything debt; a buyer who overreaches on the definition can lose the deal or pay for it elsewhere in the price. The fix is to know, before the purchase agreement is drafted, which items exist and how large they are, and to put each one somewhere deliberate: in the debt definition, in the working capital peg, or in the sources and uses as a use the financing covers. A quality of earnings review usually lists the debt-like items, and lenders read that schedule closely.
Each debt-like item is either paid by the seller at closing or paid by the buyer after it. The lender wants to know which, before it commits.
Disputes after closing, and what they do to the financing
Most purchase agreements close on an estimate of cash, debt and working capital, then true it up once the closing balance sheet is final. If the true-up says the buyer owes the seller more, that money has to come from somewhere, and the acquisition loan has already funded. If it says the seller owes the buyer, collecting depends on what security the buyer has.
- A cap or a collar on the adjustment limits how far the price can move after closing, so the buyer's cash needs stay predictable.
- An adjustment escrow, funded from the seller's proceeds, gives the buyer a source for any refund without a lawsuit; see escrow and holdback in acquisition financing.
- A right of set-off against a seller note lets the buyer deduct amounts owed from future note payments, provided the senior lender's subordination agreement allows it.
- Consistent accounting principles, defined in the agreement, keep the closing balance sheet comparable to the one the peg was set from.
Lenders pay attention to an upward adjustment that is open-ended. A working capital true-up measured on the closing balance sheet is ordinary; an adjustment that reaches into the buyer's future results is an earnout by another name, and the senior lender will want it subordinated and conditioned like one; see earnouts and acquisition debt.
What to settle before the purchase agreement
- A complete debt schedule for the target, with every loan, lease, deferred purchase obligation and lien, and a lien search to check it; the lender will ask for both.
- A list of debt-like items with amounts at the latest month-end: deposits, deferred revenue, accrued and transaction bonuses, tax balances, aged payables.
- A working capital peg set from a trailing average, with each disputed item placed consistently either in the peg or in debt, never in both and never in neither.
- Whether cash is swept entirely or a minimum operating balance stays in the company, and if so, whether the price is adjusted for it.
- The mechanism and limits for the post-closing true-up, and where any refund comes from.
Midas Partners's financing model carries the target's debt schedule, the payoffs at closing and the working capital delivered, so each lender sees the day-one balance sheet it is lending against. The debt schedule is also where hidden items tend to surface first; see business debt schedule. The full package is built in a day once the documents are in; see the package.
Common questions
- Does cash-free mean the buyer gets no cash at all?
- Usually the seller keeps the cash, but many deals leave a minimum operating balance in the company, either with a matching price adjustment or counted within working capital. Whatever the agreement says, the lender will want the company to have enough cash or availability on a revolver to operate from day one.
- Who pays off the seller's loans in a cash-free, debt-free deal?
- The seller, out of the purchase price. At closing the lenders are paid directly from the funds flow against payoff letters, and the seller receives the balance.
- Are finance leases debt in a cash-free, debt-free deal?
- They are commonly treated as debt, because they are fixed financing obligations, but it is negotiated. If they stay in the company, the buyer's lender will usually count them in funded debt.
- Are customer deposits debt or working capital?
- Either, depending on the agreement. What matters is consistency: if deposits sit in working capital, the peg must be set with them in it. Otherwise the buyer pays full price for a company that owes customers work already paid for.
- How does the definition of debt affect my loan?
- The lender sizes the loan against the obligations it can see. Items left in the company, such as leases, deferred revenue or stretched payables, either count against leverage and coverage directly or consume cash after closing that the model assumed would service debt.