What happens to cash when you buy a company?

Hey guys,

Would really appreciate some help with a probably really basic accounting question.

When you purchase a company, let's say through an LBO.... what happens to the cash of the target? Does the seller take it all with them? So, once you own the company, there's 0 cash left?

The reason I guess I am a bit confused is because you subtract cash from the EV formula....

Thanks so much guys. I know this is basic - but for some reason I'm having some trouble here.

Comments (13)

Feb 23, 2016

Cash is an asset on the balance sheet and is added to the combined balance sheet (along with all the other assets) in a merger. Say you buy a company for some amount and it has $20MM cash, $180MM other assets, $150MM Liabilities, $50MM Shareholders Equity. On your combined balance sheet you have $200MM of additional assets, and then you account for purchase price, cut the shareholders equity, add in goodwill, etc...

You subtract cash out from the EV formula because:
a) it's already accounted for in the market cap (equity value) of a public company
b) it decreases net debt/net liability and allows dividend payouts, so in essence it is a resource you are purchasing along with the company

Feb 23, 2016

a) equity value accounts for all assets. why don't we remove all them ?
b) for listed companies you'll (more or less) pay the market cap + premium + non-refi-debt-w/change of control provision
c) cause once you buy the comp you can walk straight to the coffers and take that cash. so might as well not account for it.

Feb 23, 2016

You seem to get this wrong "you subtract cash from the EV formula". Read the article below.
Short answer to your question; acquirer owns the cash in the company & pays for that cash through equity value calculation of the business.
https://www.wallstreetprep.com/blog/common-topics-...

Feb 26, 2016

Thanks for sharing the link

Feb 23, 2016

To the OP, forget about it being accounted for in equity value for a second - this should be theoretically true but this reasoning is secondary to a more practical way to think about it.

Think about what enterprise value is used for in an LBO. It represents the value of a firm if it were to be bought or sold. If a firm includes cash as a part of its sale, then you'd effectively be paying less for the company.

For example, lets consider the sale of Company X in two scenarios with the equity and debt being the same and equaling $10 for both but cash being different. In scenario one the company has no cash at sale and is worth $10, which is what you'd pay for as a private equity firm. In scenario two Company X includes $5 cash on its balance sheet. How much would you be paying if a firm essentially gave you $5 as part of $10 sale, $5, right? This is why cash is subtracted.

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Best Response
Feb 23, 2016

Except in an actual LBO, the cash is almost always swept at closing and goes to the seller.

    • 2
Feb 23, 2016
JustADude:

Except in an actual LBO, the cash is almost always swept at closing and goes to the seller.

Ding ding ding we have a winner. You also have to remember that there is typically a working capital peg set in the transaction docs. If working capital is higher at closing buyer pays seller the difference. If its lower, seller owes buyer. There can also be true ups at a later date and other fun stuff, but that's the basics of what happens to the cash. Keep in mind this is not always true, every transaction is different and there are suckers everywhere, but this is ordinarily the case.

    • 2
Feb 24, 2016

This is what I see 95% of the time

Feb 23, 2016

Good point, I should have clarified this.

Feb 26, 2016
JustADude:

Except in an actual LBO, the cash is almost always swept at closing and goes to the seller.

From a theory, modeling, and (usually) legal perspective, this is correct for a buyout of a private company almost all the time.

From a practical perspective, the business you're acquiring still has to operate, pay bills, etc.; it's practically hard to sweep every dollar of cash; and you as the buyer are funding some minimum cash balance day 1 anyway. So, often times you'll see a purchase price adjustment for cash left on the BS at close even if the deal is structured cash-free, debt-free.

Feb 24, 2016

Not sure what you're asking

Theoretically when you think about VALUE - i.e., what do I pay for this business, the cash is netted out to get to your EV. Therefore, it gives you an idea of what this business is worth. This is based simply on the fact that the buyer owns the cash so it lowers his financial burden after purchasing the company. It doesn't mean the actual cash balance on the account goes to 0.

In terms of what happens is to the cash in an actual situation, I mean it doesn't disappear and there can be closing accounts or some type of adjustment that is made to ensure sufficient cash on balance sheet so that the seller is not pillaging the cash before closing

Feb 26, 2016

Seller will always take out as much of the cash as they can and leave enough for working capital. How much working capital is reasonable is one of the most important areas of negotiation.

Feb 26, 2016
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