Cash-free debt-free: what counts as debt is negotiable

Cash-free, debt-free means the buyer pays for the business itself, you keep the cash, and every dollar the agreement calls Indebtedness comes off your wire dollar for dollar. The convention is settled market practice. The definition is not. What counts as debt is drafted, not discovered, and that drafting is the second negotiation over price.

What does cash-free, debt-free actually mean when I sell my company?

Cash-free, debt-free is a pricing convention. The headline number in the letter of intent is enterprise value, which assumes the company arrives with no cash and no debt. At closing, the buyer funds enterprise value, adds your cash, subtracts Indebtedness, subtracts your unpaid transaction expenses, and adjusts for working capital against a target.

A dollar inside the definition of Indebtedness is a dollar you do not receive. No multiple, no discount for probability. After signing, your only recourse is the agreement’s dispute mechanism, which applies the definition rather than reopening it.

At the smaller end the convention arrives as a sentence, not a formula: keep the cash and receivables, deliver the business free of debt. Same arithmetic. Many deals this size carry no true-up and no independent accountant, so the definitions are the whole negotiation.

Why is the definition of Indebtedness a second negotiation over price?

The definition of Indebtedness is a price term wearing the costume of a definition. Enterprise value gets negotiated in the open, in front of the broker or banker, with both sides watching. The definition gets negotiated in a redline three weeks later, often by accountants and lawyers, and it moves the same money.

Delaware case law shows how narrow the post-closing process is. In Chicago Bridge, the Delaware Supreme Court read a true-up as an important but narrow and cabined remedy, not a wide-ranging right to re-price by attacking the seller’s historical accounting. The seller won there, under Delaware law, on an agreement carrying a liability bar particular to it. The lesson that transfers is smaller: the closing statement applies the words you signed.

Case: Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 166 A.3d 912 (Del. 2017).

So the leverage is pre-signing. If the definition calls an item debt, whoever resolves closing disputes deducts it. Argue the definition, not the calculation.

Which items do buyers routinely try to call debt?

Buyers reach well beyond the bank loan. The usual list runs to finance leases, accrued income taxes, accrued vacation and PTO, deferred compensation and unpaid bonuses, shareholder loans, equipment and floor-plan financing, factored receivables, pension exposure, drawn letters of credit, prepayment and breakage costs, and your own unpaid transaction expenses.

Finance leases. Under US GAAP, the current standard puts finance and operating leases alike on the balance sheet as a right-of-use asset and a lease liability, subject to an election for leases of twelve months or less. Many owner-operated companies report on a non-GAAP basis, where nothing appears, so check your statements before conceding the premise. Then argue economics. A finance lease that bought a machine is borrowed money relabeled. Building rent already sits in EBITDA.

Accounting: FASB ASC Topic 842 (Leases).

Accrued vacation and PTO. The number turns on your state, not only your policy. In California, where a contract or policy provides paid vacation, vested vacation is paid as wages at the final rate on termination and cannot be forfeited, though reasonable accrual caps are allowed, a collective bargaining agreement can provide otherwise, and statutory paid sick leave is generally not payable. Where no payout is mandated, the accrual may never become cash.

Law: Cal. Lab. Code 227.3.

Factored receivables. Article 9, as enacted in your state, covers a sale of accounts, and a factor ordinarily perfects by filing like any lender, though some assignments are excluded or perfect without a filing. With recourse, treat the advance as debt and clear it. On a true sale, the receivable and its cash are both gone, and deducting both is double counting.

Drawn letters of credit. An undrawn standby letter of credit is contingent, not funded borrowing, and should count only when drawn. Once the issuer honors a presentation it is entitled to reimbursement from the applicant in immediately available funds, and that obligation is real debt.

Law: U.C.C. 9-109(a)(3) and 5-108(i), as enacted in your state.

Multiemployer pension withdrawal exposure. A complete or partial withdrawal from a union multiemployer plan makes the employer liable for its allocable share of unfunded vested benefits. On written request the plan sponsor must estimate it and explain the estimate, but the plan has 180 days, may charge the reasonable cost, need answer only once in any twelve months, and measures as of the prior plan year end. In an asset sale a statutory exception can prevent a withdrawal, but it is conditional, never automatic: an arm’s-length sale to an unrelated purchaser, a comparable contribution obligation assumed, a bond or escrow for five plan years, and a contract making you secondarily liable if the purchaser withdraws within five plan years and does not pay. Price that contingency.

Law: 29 U.S.C. 1381; 29 U.S.C. 1021(l); 29 U.S.C. 1384; 29 C.F.R. Part 4204.

Floor-plan financing. Inventory lines are debt: they funded inventory and are secured by it. The point worth arguing is whether the financed inventory is simultaneously counted as an asset in the working capital target.

Your unpaid transaction expenses. Banker success fees, legal and quality-of-earnings costs, and stay or change-of-control bonuses you promised come off the wire. They are not usually Indebtedness; they get their own line. Keep them there, define whose fees count, and cap the line.

On the tax side, stated as of September 2026, a success-based fee is not automatically deductible. In a covered transaction an electing taxpayer may treat 70 percent of the fee as not facilitating the transaction and must capitalize the rest. The election is irrevocable, is made by a statement attached to the return, and covers every success-based fee in that transaction.

Tax: Rev. Proc. 2011-29; Treas. Reg. 1.263(a)-5 (verify status the month you sign).

What counts as cash, and can the buyer make me leave a minimum balance?

Cash gets defined as carefully as debt, and buyers narrow it. The usual carve-outs are restricted cash, deposits in transit, outstanding checks, cash sitting in a foreign or dormant account, and a minimum operating balance the buyer says must stay in the business. Each carve-out is a price reduction wearing an accounting label.

• Restricted cash. Cash behind a letter of credit or a control agreement is not freely available. But if that letter of credit is also deducted as debt, one deduction goes.
• Deposits in transit. Money collected but not cleared is still yours. Use one cutoff for every account.
• Outstanding checks. If checks you wrote reduce cash, the payables they satisfy must count as paid.
• Foreign or dormant accounts. Ask for the computation behind any haircut, and have your accountant confirm the tax cost as of the month you sign.
• Minimum operating balance. Cash left behind funds the buyer’s opening float. Put it on the closing statement as its own number, so it can be traded.

I ask for the last three bank reconciliations before I accept any number labeled cash.

How does double counting between debt and working capital cost me money?

Double counting is the most expensive error in a cash-free, debt-free deal. It happens when an item is deducted as Indebtedness and also sits as a current liability inside the working capital target. It happens in reverse too, when an item is scrubbed from the closing calculation but left in the target.

Work the numbers. Accrued PTO is 200,000 dollars and the target was built from months that included the accrual. Deduct it as Indebtedness and leave it in the closing calculation, and you pay on the debt line and again on a depressed working capital figure. Two hundred thousand of exposure becomes four hundred thousand of price.

The mirror error is subtler. Exclude the accrual from the closing calculation but leave it in the target, and the target is inflated by exactly that amount.

An item may be debt. An item may be working capital. An item may not be both, and the target must use the same definition as the closing statement.

The pressure is one-directional, and that is why buyers push. A debt deduction cuts price dollar for dollar; an EBITDA adjustment cuts it by the multiple. A buyer facing a recurring lease payment can call the rent an operating expense or capitalize the obligation and call it debt. It picks the worse column, sometimes both.

Does an SBA-financed buyer change how the debt lines work?

An SBA 7(a) buyer changes the mechanics of your closing statement, because the lender has its own rulebook about what it will fund and how the buyer’s equity is proven. As of September 2026 the operative guidance is SBA SOP 50 10 8, effective June 1, 2025. Check for a newer version.

Two features matter to a seller. A complete change of ownership requires an equity injection of at least 10 percent. A seller note counts toward it only if it is on full standby for the life of the SBA loan and only up to half of the injection. Full standby means no principal and no interest paid to you until the SBA loan is repaid. Lender rules are not negotiable between you and the buyer, so treat a standby note as a deferred, subordinated claim, not as price.

How should the Indebtedness definition be drafted so it holds up at closing?

The Indebtedness definition should be a closed, enumerated list. An open definition that says “including, without limitation, all obligations of a debt-like nature” hands the buyer’s accountants a blank check to write on the day of the closing statement, and any dispute mechanism will apply it as written.

• Close the list. Enumerate the categories and delete any catch-all for items “in the nature of” debt. Expect resistance where the buyer’s lender wants breadth.
• Add an anti-double-count sentence. No item in Indebtedness or Transaction Expenses may also be a liability in Working Capital or the Working Capital Target, and no item may be counted twice in any calculation of price.
• Tie the target to the same definitions. Compute the Working Capital Target using the same accounting principles, line items and exclusions as the closing statement, and attach that computation as a schedule.
• Attach a sample calculation. Run the finished definitions against your latest month-end balance sheet and attach the result. State that it controls in a conflict, because an example that does not control resolves nothing.

The sample is the discipline that catches everything else. If it produces a result you would not accept on closing day, you found the problem in time.

A definition you have never run against a real balance sheet is a definition you have not read.

What should I do in the next two weeks?

Concrete preparation beats argument later. The work below can be finished before a letter of intent is signed, and it is the cheapest leverage in the process, because every item resolved now is an item the closing statement cannot reprice.

• Mark every liability on the latest balance sheet as debt, working capital, or neither. What you cannot classify, the buyer will.
• Get written payoff quotes from every lender, including prepayment penalties, defeasance and swap breakage, with a good-through date. The cost of retiring debt belongs in the deduction once, at the quoted amount.
• Have your accountant compute income taxes accrued to an assumed closing date, entity and state, as of the month you sign.
• Compute the PTO accrual at final rates under each state’s law where you employ people.
• Run a UCC search on your own company and find the filings first.
• If you contribute to a multiemployer plan, request the estimate in writing now; the plan can take 180 days to answer.
• Clear every shareholder loan, related-party balance and personal expense.
• Ask that the letter of intent outline the cash and debt definitions and require the anti-double-count provision.

I read the loan agreements and the lease schedule before I read the letter of intent, because the letter describes a price and the loan agreements describe what comes out of it.

Enterprise value is the number you tell people. Equity value is the number that reaches your account. The distance between them is written in the definitions, and negotiable until you sign.