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What Is Meant By "Cash Free/Debt Free"?


For further information in relation to this article, please contact Daniel McCormack.

Heads of terms entered into between a seller and a buyer often state that the target company or business is to be acquired on a "debt free/cash free" basis. On recent "vendor-led" auction processes that the Lupton Fawcett corporate team have worked on, competing offers being made on a "cash free/debt free" basis has allowed the vendor to compare offers on a like for like basis. It is therefore important to understand and agree upon the meaning of "debt free/cash free".

Typically, if a business is to be acquired "debt free", most parties will intend that all external debts (i.e. bank debts) be repaid upon completion. However, what about trading debts arising in the ordinary course of business? What about hire purchase and finance leasing agreements or intra company debts? Do these also constitute "debts" which should be discharged upon completion in order to achieve a "debt free/cash free" position?

A sensible starting point for the debate is to identify exactly what debt the target currently has, and more specifically the likely level of that debt at the point of proposed completion. "Debt free" can be achieved in a number of ways:

  • The target repays the debt prior to completion;
  • The seller repays the debt prior to completion;
  • The debt remains in the target company, with arrangements put in place to discharge the debt immediately following completion or
  • The buyer assumes the debts but reduces the purchase price by an amount equal to the debt.

As regards the concept of a target being acquired "cash free", again a sensible starting point is to agree what is meant by "cash". Usually, the term cash free does not mean that the seller will be entitled to empty the target bank accounts immediately prior to completion. A more likely intention is that the seller will be permitted to remove any "spare" cash before the target is sold. "Cash free" can be achieved by using the "spare" cash in a number of ways including:

  • Repayments of indebtedness (which goes towards achieving "debt free");
  • Pre-completion dividend (subject to the target having sufficient distributable reserves);
  • Purchase of own shares (subject to the target having sufficient distributable reserves); and
  • Pension payments to individual sellers.

It is important to remember that the buyer's interpretation of "debt free/cash free" will almost certainly be made on the assumption that the target company will be left with adequate working capital. The buyer will normally expect that the target will be able to continue to trade for the foreseeable future immediately following completion. It is imperative that there is a clearing understanding from the outset of what debt free/cash free means, along with related concepts such as "enterprise value" and "equality value" that can only help achieve a great result for all parties to the deal.

Please note this information is provided by way of example and may not be complete and is certainly not intended to constitute legal advice. You should take bespoke advice for your circumstances.

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