Mark: Invariably, when a buyer offers up to a target company a term sheet or a letter of intent, it has a headline valuation based on certain assumptions and the buzzwords, “on a cash-free, debt-free basis.” What do those buzzwords mean?
Ramy: Yeah, cash-free, debt-free is a term of art. It's meant not to say that the company can't have any cash or any debt, but it's meant to isolate the stated purchase price that's negotiated from any cash that the company may have, which would increase that purchase price, and any debt or debt-like items that the company may have, which would decrease the purchase price.
Mark: So, you take that headline price, the seller gets an upward adjustment for its cash on hand and gets a downward adjustment for its debt on hand at closing. Is debt just bank borrowings, true debt, or is there more to it?
Ramy: Usually it's broader than that. So other debt-like items could be pre-closing taxes, sometimes deferred revenue, oftentimes long-term deferred revenue. And then certain other employee-related accruals or liabilities, such as severance costs, things like that.
Mark: So, it's important to understand that quote-unquote debt-like items has variability in it. It's a negotiated term. It can have things in that category that you would not normally think of debt, but it's a way for a buyer to have its purchase price not be diluted by incremental liabilities that it has to assume. So, it's an economic negotiation between parties.
Ramy: Highly negotiated definition, yeah.