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Cash-Free Debt-Free: Why It's Used and Impact on Enterprise Valuation

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What does cash free debt free mean?

Cash-free debt-free simply means that when an acquirer buys another company, the transaction will be structured such that the buyer will not assume any of the debt on the seller's balance sheet, nor will the buyer get to keep any of the cash on the seller's balance sheet.

From the seller's perspective, cash free debt free means that:

  • Seller keeps cash: The seller gets to keep the cash that is on their balance sheet at the time of closing, except for a usually negotiated amount of "operating" cash that is considered a minimum amount that needs to transfer over in the sale to keep the operations of the freshly acquired business running smoothly.
  • Seller keeps debt: The seller's debt obligations have to be paid off by the seller.

Cash-free debt-free means the enterprise value = purchase price

Because the acquirer does not have to assume the seller's debt (nor get the benefit of the seller's balance sheet cash), the acquirer is simply paying the seller for the value of the core operations of the business, i.e. the enterprise value.

In CFDF deals, the purchase price delivered to the seller is simply the enterprise value.

As a result, when deals are structured as cash-free-debt-free, the purchase price delivered to the seller is simply the enterprise value. By contrast, an acquisition where the acquirer acquires all of the seller's assets (including cash) and assumes all the liabilities (including debt), the purchase price delivered to the seller would need to be adjusted by taking the enterprise value and subtracting out the seller's existing net debt and purchasing just its equity).

Cash-free debt-free: A simple example

Cash-free debt-free (CFDF) Example

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 (10 times JoeCo's last twelve months EBITDA of $100m).

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

Let's ignore all transaction and financing fees for simplicity.

Scenario 1: Deal structured on a cash free debt free basis

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

Note that from the buyer's perspective, since there's $0 net debt that goes along with this newly acquired business, the equity value of the newly acquired business is simply $1 billion - the same as the enterprise value.

From the buyer's perspective, the equity value of the newly acquired business is simply $1 billion - the same as the enterprise value.

What happens to that debt and cash? The seller receives the $1 billion purchase price, pays off the $180m in net debt ($200m, net of the $20m in excess cash they didn't deliver to the buyer).

Bottom line: The seller keeps $1 billion - $180m = $820m.  This is the equity value to the seller.

Scenario 2: Acquirer assumes all seller debt and gets all seller cash

Now what would things look like if the same deal was instead structured such that the acquire assumes all liabilities (including debt) and acquires all assets (including cash)?

Enterprise value = $1 billion.  It is the same: 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:

Enterprise value $1 billion
Less: Net debt $180m
Equals: Equity purchase price $820m

Bottom line: From the seller's perspective, they get $820m instead of $1 billion, but they don't have lenders to pay off.  Both approaches (ignoring any tax or other nuances that usually create a preference for cash free debt free), both approaches are economically identical.  

Cash-free debt-free in practice

Most private equity deals are structured on a cash-free debt-free basis.

Usually, the letter of intent will contain language that will establish that the deal will be transaction on a cash free debt free basis.

However - and importantly - 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: Imagine you're a seller thinking you get to keep $5 million in cash but at late stages of the deal the the private firm begins to argue that $3 million of that is intrinsic to the operations of the business and should come over with the company.

Why cash-free debt-free?

Since most deals are valued off EBITDA, cash-free debt-free 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 - it 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 JoeC example, the 10x EBITDA valuation exactly becomes the purchase price, aligning 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. These types of deals will not be structured as cash-free debt-free and the acquirer will instead either acquirer each share via an offer price per share or acquire all the assets (including cash) and assume all the liabilities (including debt).

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