Net debt, explained simply
In a cash-free, debt-free deal every dollar of net debt and debt-like items reduces the seller’s proceeds. The definition in the purchase agreement therefore matters: which borrowings are included, which cash is free to use, and how leases are treated.
Cash that is not freely available, such as customer deposits or balances required by lenders, is often excluded.
Building net debt
IllustrativeAlder Creek Manufacturing at closing, $ millions
Calculation
Worked example
| Alder Creek at closing, $ millions | Amount |
|---|---|
| Term loan | 5.5 |
| Line of credit | 1.0 |
| Equipment finance leases | 0.6 |
| Less: cash | (1.2) |
| Net debt | 5.9 |
| Add: debt-like items | 2.1 |
| Total deducted from price | 8.0 |
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Enterprise value of $36.8 million, less $8.0 million, less the $0.2 million working capital shortfall at closing, leaves about $28.6 million for the shares.
Why it matters in a deal
Net debt and debt-like items reduce the seller’s proceeds dollar for dollar, and are heavily negotiated.
Red flags
- Cash that cannot be freely used, such as customer deposits
- Debt repaid before closing using cash that should have remained in working capital
- Undisclosed loans or guarantees