We are negotiating a debt-free cash-free deal structure, but the buyer's team is trying to classify our long-term software subscriptions and pre-paid annual maintenance contracts as debt-like items. How do we define these liabilities in the purchase agreement to prevent them from being deducted dollar-for-dollar from our cash at close?

Question

Tyler Smith · Accepted Answer

Almost all letters of intent specify that the transaction will be completed on a debt-free, cash-free basis. While this sounds straightforward, it often leads to intense negotiation over how deferred revenue is treated at close. If your business collects upfront annual payments for software-enabled services or long-term maintenance contracts, you hold cash on your balance sheet for services that have not yet been delivered.

Buyers will argue that this deferred revenue represents a future performance liability and should be classified as a debt-like item, which would be deducted dollar-for-dollar from your purchase price at close. At the same time, they expect to keep the cash associated with those pre-payments to fund the ongoing operations. This is a double penalty for the seller.

To defend against this, you must clearly define how deferred revenue is treated during the LOI drafting stage. Negotiate to treat deferred revenue as a component of working capital rather than a debt-like liability. Prove that your cost of delivery for these pre-paid contracts is highly automated and represents only a fraction of the deferred revenue value. By restricting the buyer's ability to classify deferred revenue as debt, you protect your cash at close and ensure your working capital peg accurately reflects your operational model.