What Debt-Free, Cash-Free Means
When a deal is structured on a debt-free, cash-free basis:
- Debt-free: All interest-bearing debt — bank loans, lines of credit, seller notes from prior deals, capital leases — is paid off at closing from the proceeds. The buyer acquires the business with a clean balance sheet.
- Cash-free: The seller retains all cash on the balance sheet at close (above the minimum operating cash included in the working capital peg). Cash does not transfer to the buyer.
This is intuitive: the buyer is buying the earnings power of the business, not a specific balance sheet configuration. The business is valued based on EBITDA — debt and excess cash are separate from that earnings stream.
How DFCF Plays Out at Closing
In practice:
- Buyer wires total consideration to the closing agent
- Closing agent pays off all outstanding debt from the proceeds (using a payoff letter from each lender)
- Seller receives remaining proceeds (enterprise value minus debt payoffs, adjusted for working capital)
- Seller's bank accounts (operating cash, retained earnings) are swept to the seller before or at close
What Counts as "Debt" in DFCF
The purchase agreement defines debt precisely, and the definition is negotiated. Standard items:
- Bank term loans and revolving credit facilities
- Capital lease obligations
- Notes payable to shareholders or related parties
- Deferred financing fees (negative adjustment)
"Debt-like items" — often treated similarly in the equity value bridge but sometimes negotiated separately:
- Deferred revenue beyond normal operating levels
- Accrued but unpaid bonuses and vacation
- Unfunded pension liabilities
Seller opportunity: Surplus cash on the balance sheet is yours to keep before closing. Many sellers don't realize they can declare a dividend or make a distribution from retained earnings shortly before close — as long as the working capital peg is met and the transaction documents don't restrict it. Confirm with your M&A attorney and accountant.
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