Deal Structuring
Many people will have heard the term “cash and debt free” in relation to deal mechanics, but what does it actually mean for you and your business if you're considering a sale?
A valuation will ordinarily start with an enterprise value - there are a number of ways to arrive at that figure, but typically it will be reached by attaching a multiple to your sustainable EBITDA figure (Earnings Before Interest, Tax, Depreciation and Amortisation). So if your business is making £1m EBITDA and the agreed multiple is 5x, you'll get an enterprise value of £5m.
You'll then generally hear that this offer is made on a cash and debt free basis. In many ways, that's exactly how it sounds; you get to keep all of the cash in the business, minus any debt. If that calculation results in a positive figure, it gets added to the consideration. If it's a negative figure, it comes off the total. That final figure is known as your equity value.
Because most owner-managed businesses build a significant cash surplus over the years of operation, this can be a particularly attractive structure for owner-managers to extract those excess cash profits in a tax-efficient way.
The next line you'll typically read in an offer letter is that this is subject to leaving a normalised level of working capital. In real terms, that means the business functions on a certain pool of current assets and liabilities which are constantly required for the day-to-day churn of the business (trade debtors, stock, trade creditors being core examples). Your working capital in a given month is all of the working capital assets, less all of the working capital liabilities. Because that number will naturally change month to month, you and the buyer will agree a fair working capital target, which reflects the “normalised” position, typically formed using an average, which should be left on the balance sheet. If you deliver working capital above this target, the value comes out £ for £ to you on top of the surplus cash calculation. So if the working capital target is agreed at £1m and you deliver £1.1m, you get that extra £100k. If you're below it, the reverse applies and this deficit amount comes off your surplus cash. Practically, this protects both parties from arbitrary working capital movements caused by timing differences.
There are quite a few technical nuances to this, and a good adviser can be key in maximising the value you receive out of that calculation. In particular, consideration needs to be given to what should be considered cash, debt or working capital in the first place, what period the working capital target should be determined over, whether any normalisations should be applied and what completion mechanism you are going to use; completion accounts or locked box (if you're curious to know more about those terms, why not check out our article on Locked Box or Completion Accounts). If you'd like to learn more about the sales process and how we can help, we're always happy to have a no-obligation conversation.
This article is general information only and is not tax, legal or accounting advice. Deal structures should always be reviewed with your own adviser before you agree terms.