I came across multiple conflicting definitions for cash-free/debt-free deal terms.
For example, one source says it "means that when a buyer purchases a company and its assets, it is on the basis that the seller will pay off all debt and extract all excess cash prior to completion of the transaction."
However, I think this definition eludes logic.
If the seller keeps all the (excess) cash and pays off all debt, then why would I pay the EV, which implicitly assumes that I pay off the debt-holders/capital structure?
The capital structure changes after a transaction. There is a new amount of debt / equity. You aren't paying off existing debt holders (unless negotiated that you would).
If you do a LBO there will be new debt on the business. You will have to pay that off.
EV is the value of the business. If you don't pay it, then someone else will.
Its a lot more nuanced than that in reality.
The idea of cash free debt free is to give the shareholders a clear view of what they are going to receive. This does not necessarily equate to what the buyer is paying by the way. Also cash free debt free is typically short-hand for cash free, debt free with a normalised level of working capital.
Lets try and take a simple example.
Lets say company A is valued at an EV of £100 (sorry-am based in the UK) with debt of £20 and free cash (needs to be free and not trapped) of £10. There are different scenarios that could play out but in this instance, you could use that £10 to pay of the corresponding amount of debt. If there are no other EV to equity adjustments (and there will be e.g. the working capital adjustment I alluded to above!) the buyer would draw down £100, £10 would go to the bank and £90 would go to the shareholders.
Alternatively there could be zero debt and £50 of cash on the bank. In the UK anyway there ways to "up stream" the cash so the buyer doesn't need to drawdown on an additional £50 and the vendors can extract without it being taxed as a dividend (though the reality is that this is easier send then done).
The above is all sorted in the completion mechanism (completion accounts or typically in the UK locked box) and funds flow. These do get less of a mention on WSO but are a core component of an IB's skill set.
Also happy to go into further detail if useful e.g. corporate tax, leakage items, deferred revenue: debt vs w/c. There is a lot!
More detail would be great! Starting as an analyst and trying to get my head around this.
So all cash is extracted or used to pay down debt, the buyer then reduces amount paid by the leftover net debt ( and nwc adjustments). Does the buyer then choose to either refinance the debt or pay it down with the cash? Presume you wouldn't pay it down unless necessary.
Also, how does the business operate in the transition period with no cash? For payroll etc? Does the buyer need to input cash on day 1?
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