In business valuations, ‘Debt Free Cash Free’ is a commonly used term that impacts the sale process. At Avondale, we know that selling your business is a huge step and one that will have a far-reaching, and hopefully positive impact on your future. However, the business sale journey will take you down many new avenues and introduce you to a whole new language as each piece of the puzzle fits together. Today we are going to focus on translating the frequently used phrase – ‘Debt Free Cash Free’ and look at how it impacts business valuations.
When a party makes an offer, it will typically be linked to their expectations of the current and/or future profits and discounted cash flows of the business and this headline price is referred to as the ‘enterprise value’. However, this value does not take into account the timing of the transaction and the level of funding required or existing in the business and therefore the enterprise value is predicated on the assumption that the business is acquired debt-free and cash-free and has the required level of working capital on completion. These adjustments are referred to as the ‘equity value bridge’ and the value of the business after these adjustments is referred to as the ‘equity value’.
Adjusting to achieve a ‘debt-free’ business, essentially means that any external debt in the business, such as leases, hire purchase loans, bank loans, director’s loans, and corporation tax liabilities are deducted from the valuation and repaid on completion – any trade debt remains with the business post-sale. The ‘cash-free’ element of the equity value is assessed by looking at how much cash there is in the business and typically results in an upwards adjustment to the equity value allowing the seller to extract this surplus cash on completion.
Stripping out the excess cash is great for you, as the seller, but from the purchaser’s perspective we need to ensure that there is sufficient working capital remaining in the business on completion and this is calculated by deducting the current operating liabilities (trade creditors, accruals, and payroll liabilities) from the current operating assets (stock, trade debtors and prepayments). If a business is subject to seasonality in its working capital requirements, an average position will be determined by looking at historic monthly data.
As you can imagine, these adjustments can be subject to heavy negotiation by the purchaser and therefore we always review these components with our clients as we prepare their business for sale and collate the financial data – this helps to provide clarity on expected valuations from the start.
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