The buyer's Quality of Earnings team is trying to classify our annual upfront customer payments as debt-like items to reduce our cash proceeds at closing. How do we defend these prepayments as operational working capital by showing how our team uses them to fund daily delivery?

Question

Tyler Smith · Accepted Answer

If your business collects annual upfront payments or retainers, buy-side Quality of Earnings auditors will almost certainly try to classify this deferred revenue as a debt-like liability. They want to subtract this amount dollar-for-dollar from your purchase price at closing, claiming you have already spent the cash for work you have not yet performed. To defeat this tactic, you must prove that these prepayments are a normal part of your operating cycle and constitute working capital, not debt. Show the auditors your historical cash flow cycle and demonstrate how your team manages these funds. Use your Accountability Chart to show that your delivery teams are structured to fulfill these contracts efficiently without requiring additional capital injections. Present data proving your historical retention rates and the low actual cost of delivery for these prepaid contracts. Argue that this cash is operational working capital necessary to run the business day-to-day. If the buyer insists on an adjustment, negotiate a working capital peg that includes deferred revenue, ensuring you are credited for the cash required to service those customers post-close. This protects your cash proceeds and prevents the buyer from getting a free ride on your historical cash-generation engine.