Cash-Free Debt-Free (CFDF)

How Do Cash-Free Debt-Free Transactions Work

In practice, most leveraged buyouts (LBOs) – i.e. the transactions that private equity firms specialize in – are structured on a cash-free debt-free basis (CFDF).

Frequently, the letter of intent (LOI) will contain language to formally establishes that the transaction structure will be on a cash-free debt-free basis (CFDF).

However, the definition of what counts as cash and what counts as debt is not finalized and negotiations may continue about this up until the close, making the cash-free debt-free basis structure a sometimes delicate point of negotiations.

For instance, suppose you are a seller thinking you’ll get to keep $5 million in cash, but the private firm argues that $3 million of that is intrinsic to the operations of the business and should come over with the company in the late stages of the deal.

Learn More → Issues in Negotiating Cash-Free Debt-Free Deals (PDF)

Cash-Free Debt-Free Transaction Calculator

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Step 1. CFDF Transaction Assumptions

Suppose WSP Capital Partners, a private equity firm, seeks to acquire JoeCo, a coffee wholesaler and retailer.

WSP Capital Partners believes JoeCo deserves an enterprise value of $1 billion, representing 10.0x JoeCo’s last twelve months (LTM) EBITDA of $100m.

• Enterprise Value = $1 billion
• Purchase Multiple = 10.0x
• LTM EBITDA = $100 million

JoeCo has $200mm in debt on its balance sheet, along with $25m in cash on its balance sheet, of which $5m the buyer and seller jointly agreed to consider “operating cash” that will be delivered to the buyer as part of the sale.

• Existing Debt = $200 million
• Cash on B/S = $25 million
• Operating Cash = $5 million
• Excess Cash = $20 million

Note: Our illustrative LBO model will ignore all transaction and financing fees for simplicity.

Step 2. LBO Cash-Free Debt-Free Transaction Example

Since the buyer is only buying the enterprise value, the buyer simply defines the purchase price as $1 billion, which is the enterprise value.

From the buyer’s perspective, since there’s $0 net debt that goes along with this newly acquired business, its equity value is simply $1 billion, i.e. the same as the enterprise value.

So, what happens to the debt and cash on the seller’s balance sheet?

The seller receives the $1 billion purchase price and pays off the $180m in net debt ($200m, net of the $20m in excess cash).

• Purchase Enterprise Value (TEV) = $1 billion
• Assumed Debt = $180 million
• Excess Cash on B/S = $20 million
• Equity Value = $1 billion  –$200 million + $20 million = $820 million

The proceeds to the seller amount to $820m, which is equal to the equity value.

• Exit Proceeds to Seller = $1 billion  –$200 million + $20 million = $820 million

Step 3. LBO Non-CFDF Transaction Example

In contrast, suppose the same LBO transaction was NOT structured on a CFDF basis.

So, how would things look like if the same LBO deal was instead structured such that the acquirer assumes all liabilities (including debt) and acquires all assets (including cash)?

Given the non-CFDF transaction assumption, the acquirer will assume all seller debt and gets all seller cash.

The enterprise value remains $1 billion, so enterprise value is NOT impacted.

Of course, this time, the buyer is not just buying the enterprise, the buyer also assumes the $200m in debt, slightly offset by $20m in cash. The acquirer is still getting the same business, just with a lot more debt.  So, all else equal, the buyer would define the purchase price as:

• Purchase Equity Value = $1 billion – $180 million = $820 million

From the seller’s perspective, $820m is received rather than $1 billion, but the seller has no lenders to pay off.

Under either scenario – ignoring any tax or other nuances that usually create a preference for a cash-free debt-free structure (CFDF) – the two approaches are economically identical.

Step 4. Cash-Free Debt-Free Transaction Analysis (CFDF)

Since most M&A deals are valued off EBITDA, the cash-free debt-free (CFDF) structure is conceptually simpler and aligns with how buyers think about the value of potential targets to acquire.

How so?

EBITDA is a measure of operating profitability independent of cash or debt. In fact, the EBITDA metric is solely a function of the businesses’ core operations, regardless of how much excess cash or debt is sitting on the company’s books.

In our JoeCo example, the 10.0x EBITDA entry multiple determines the purchase price, aligning the valuation with the purchase price from the acquirer’s perspective.

The exception to CFDF structure is when the target company is public (i.e. “go-privates”) or in larger mergers & acquisitions.

In conclusion, those types of M&A deals will not be structured as cash-free debt-free (CFDF). Instead, the acquirer will acquire each share via an offer price per share or acquire all the assets (including cash) and assume all the liabilities (including debt).