What does cash-free, debt-free mean in a sale, and what do I actually receive at closing?

A letter of intent that says the price is "on a cash-free, debt-free basis" is telling you the number is not your payout. It is the price of the operating business. Your payout is what is left after the debt is gone and the balance sheet has been settled.

What it means

In a cash-free, debt-free deal the buyer does not take on your debt and does not pay you separately for the cash you hold. As Wall Street Prep puts it, the price delivered to the seller is the enterprise value. The seller pays off outstanding debt and keeps the excess cash, apart from a negotiated amount of operating cash that stays with the business.

Why buyers use it

It makes the price easy to compare. The buyer is paying for the earnings of the business, whatever the capital structure behind it. Most private equity buyouts are structured this way, and the LOI usually sets it out.

The bridge from headline to wire

Here is a hypothetical with round numbers. Your LOI says $20M, cash-free and debt-free.

Headline price: $20.0M

• Minus debt and debt-like items paid at closing: $2.0M
• Plus cash above the agreed operating level: $1.5M
• Minus a working capital shortfall against the target: $0.2M
• Minus seller transaction costs: $0.6M
• Cash to shareholders at closing: $18.7M

That is 93.5 percent of the headline, before taxes, escrow, and how the money is split between investors, founders and employees. A different balance sheet gives a different answer.

Where the arguments happen

The definitions are not fixed when you sign the LOI. Wall Street Prep notes that what counts as cash and debt is often still being negotiated up to the close. A buyer may argue that part of your cash belongs to the business.

Debt-like items are the other fight. In a worked example published by RSM US, the cash settlement drops from 42,661 to 35,141 (the report's units) once restricted cash, imputed tax on foreign cash and debt-like items such as accounts payable, accruals and deferred revenue at 50 percent are counted. That is about 18 percent lower (our arithmetic on RSM's figures). Buyers sometimes argue for items such as deferred revenue, accrued bonuses, customer deposits and unpaid taxes. Whether each one counts is a negotiation, not a rule.

What to do before exclusivity

• Ask the buyer to write down their definition of debt, debt-like items, cash and the working capital target. Do it before you sign the LOI.
• Build your own bridge from the headline price to a wire amount, and update it every time the numbers change.
• Have an accountant check the working capital target against your last twelve months, not one good month.
• Ask where venture debt, deferred revenue and unpaid taxes land.

Once you grant exclusivity, your leverage drops. Settle the definitions while the buyer still needs you.

This is general information, not legal or tax advice.

Related reading: What are working capital adjustments and escrows, and how much of my sale price will I actually get at closing; What Is a Quality of Earnings Report and Why Does Every Buyer Require One; What is a letter of intent (LOI) in M&A; What Is Venture Debt and When Should a Startup Use It.