Our business model relies on upfront annual customer retainers, which creates a large deferred revenue liability on our balance sheet. The buyer wants us to pay off this deferred revenue at close or treat it as debt. How do we negotiate the working capital treatment of deferred revenue?

Question

Tyler Smith · Accepted Answer

Buyers frequently try to classify deferred revenue as a debt-like liability, which would reduce your purchase price dollar-for-dollar at close. Their argument is that they are inheriting the obligation to perform services post-close without receiving the cash. However, this argument ignores the operational reality of running a subscription or retainer-based business. If you are operating a cash-free, debt-free deal, treating deferred revenue as debt is a double-dip because the working capital needed to service those customers is already left in the business as part of the net working capital peg. To fight this, you must argue that deferred revenue is an integral part of your operating working capital cycle. Under IVS 105, working capital must reflect the normal operating requirements of the business. You should propose a compromise where deferred revenue is included in the net working capital calculation, and the cash required to service that deferred revenue is left on the balance sheet at close. This cash amount should be calculated based on your actual cost of goods sold to fulfill the contracts, not the gross contract value. This ensures the buyer has the cash needed to deliver the services, while you retain the remaining profit portion of the upfront payments. This structure protects your cash proceeds and prevents the buyer from getting a windfall of free future performance.