The buyer is proposing a standard cash-free debt-free transaction structure, but we have a large amount of deferred revenue on our balance sheet from annual prepayments. How do we negotiate the treatment of this deferred revenue so we do not end up handing over free cash to the buyer at close?

Question

Tyler Smith · Accepted Answer

In a standard cash-free debt-free transaction, the buyer expects to inherit a normalized level of net working capital. However, if your business collects annual prepayments, you will have a significant amount of deferred revenue on your balance sheet. This represents cash you have already received for services you have not yet delivered.

Buyers will often argue that because they must perform the future services, you must leave the cash associated with that deferred revenue in the business at close. This can result in a double whammy where you lose both the cash and the revenue multiple value.

To protect your cash proceeds, you must negotiate a specific working capital adjustment for deferred revenue. Argue that the deferred revenue should be excluded from the net working capital calculation. Instead, structure a mechanism where you keep a portion of the cash to cover your historical cost of acquisition, while leaving enough cash to cover the buyer's actual direct cost of delivery, plus a reasonable margin.

Use your historical cost tracking to prove exactly what it costs to service these clients. If your gross margin is sixty percent, you should not leave one hundred percent of the cash in the business. Insist on keeping the forty percent profit margin at the closing table. Documenting these delivery costs clearly prevents the buyer from using standard accounting definitions to pocket your hard-earned cash.