The buyer offered seven times EBITDA on a cash-free, debt-free basis, but their deal counsel is treating our upfront deferred revenue and customer deposits as working capital debt that reduces the closing wire. How do we fight this debt-like deduction?

Question

Tyler Smith · Accepted Answer

In lower middle market transactions, buyers frequently use the mechanics of cash-free, debt-free terms to claw back purchase price at the closing table. The primary battleground is deferred revenue and customer deposits. Acquirers argue that deferred revenue represents an unfunded future liability: the operational obligation to fulfill services post-close without collecting future cash. They classify it as indebtedness and deduct it dollar-for-dollar from the enterprise value.

To defeat this deduction, you must prove that the actual cash cost to fulfill that deferred revenue is already accounted for within normal working capital. Demand that your sell-side Quality of Earnings team analyze your gross margin profile for fulfillment. If your historical gross margin is fifty percent, the actual cash cost to fulfill that deferred revenue is only fifty cents on the dollar, not one hundred percent. Treating the full balance as debt hands the buyer an unearned cash windfall.

Argue for one of two standard structural defenses in the definitive agreement:
- Include deferred revenue entirely within the Net Working Capital target calculation rather than treating it as indebtedness, neutralizing its impact on closing cash.
- If the buyer insists on a debt-like deduction, limit the reduction strictly to the direct fulfillment cost (COGS required to deliver the service) rather than the gross billing balance.

Align your finance seat on the Accountability Chart to isolate customer deposits from operating cash well before going to market. Establishing this treatment upfront in the LOI prevents the buyer from quietly slicing millions off the closing wire.