We collect cash upfront for our annual automated support contracts, creating a large deferred revenue balance. The buyer wants to treat this deferred revenue as debt and subtract it from our purchase price at close. How do we structure the deal to prevent this cash drain?

Question

Tyler Smith · Accepted Answer

This is a common battleground in transactions involving tech enabled service providers and SaaS companies. Buyers often try to classify deferred revenue as debt because the cash has already been collected but the service has not yet been fully delivered. They argue that they are taking on the liability to service those customers post close without receiving the cash to do it. You must aggressively fight this classification. Deferred revenue is not debt; it is a fundamental component of your working capital model. Your automated workflows and systems mean your actual cost of delivery is incredibly low. To prove this, calculate your true cost of goods sold to service those contracts. Show the buyer's QofE team that your automated delivery system allows you to service these contracts at a very high gross margin. The actual cash cost to fulfill the remaining contracts is only a fraction of the deferred revenue balance. Offering to leave a working capital reserve equal to the actual cost of delivery, rather than the gross deferred revenue amount, is a highly effective compromise. Furthermore, explain that this upfront cash cycle is a key value driver of your business. It allows you to fund operations without outside capital, which increases your overall enterprise value. Do not let the buyer treat your highly efficient cash conversion cycle as a liability to discount your hard earned valuation at the closing table.