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Financial Due Diligence - Net Debt in a Business Transaction

When buying or selling a business, the deal is often completed on a debt and cash free basis. As a result, debt and cash need to be identified in order to be adjusted out of the purchase price.

This article is written to cover the basics of net debt and financial due diligence considerations.

Purchase Price Impact

The completion mechanism within a Sale and Purchase Agreement (SPA) provides for a dollar for dollar adjustment to the base purchase price for net debt. As such, if a debt-like item is identified and agreed upon by both the buyer and seller, the purchase price would decrease by that amount.

When net debt is not correctly identified, it increases the overall funding requirements of the transaction (i.e., requires a higher investment by the buyer for the same earnings). As such, this would reduce the return on the investment for the buyer

Determining Net Debt

Net debt is defined as debt less cash. However, debt is not just "reported" debt and cash is not just "reported" cash. Debt includes "debt-like" items and cash excludes "trapped" cash.

Debt-like items include reported debt, such as bank loans and accrued interest, in addition to items with debt-like features. Examples of these may include:

  • Pension liabilities

  • Capital leases

  • Litigation costs and/or settlement

  • Accrued bonuses

  • Management year-end bonuses

  • Future commitments and obligations

  • Debt break costs

  • Guarantees

  • Promissory notes

  • Change in control payments

Cash includes reported cash and short-term securities. Examples of items that are classified as cash but are not freely available may include:

  • Cash trapped in overseas jurisdictions

  • Cash held in escrow

  • Bank deposits held as security

Financial due diligence helps a buyer identify potential debt-like items and trapped cash of a Target, however, many times these items are subject to negotiation between the buyer and seller.

If you have questions or want to connect, email us at

Disclaimer: The information contained in this article is for general guidance only. The information presented should not be acted upon without the advice and guidance of a professional tax, legal, or financial adviser who is familiar with all the relevant facts.

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