We are arguing with the buyer over the definition of cash-free debt-free transaction terms, specifically regarding how our customer prepayments and deferred revenue are treated at closing. How do we structure this to avoid funding their post-closing operations with our cash?

Question

Tyler Smith · Accepted Answer

In a typical cash-free, debt-free transaction, the buyer expects to inherit enough working capital to run the business. However, if you collect significant upfront customer prepayments or have large deferred revenue balances, the buyer may argue that this cash must stay in the business to fund future performance obligations.

To protect your cash, you must establish a clear definition of working capital and deferred revenue treatment during the LOI stage. First, separate customer deposits from operating cash. Argue that customer prepayments are a liability that you have already partially fulfilled through spent operational costs. If the buyer wants to keep all prepayments, they must credit your purchase price dollar-for-dollar.

Second, use your financial Rocks to clean up your balance sheet before entering diligence. Show the buyer your exact cost of fulfillment for that deferred revenue. If it only costs you forty cents on the dollar to deliver the service, the buyer should not get a hundred percent of the cash.

Third, negotiate a working capital peg that accounts for these prepayments. The peg should reflect a normalized level of deferred revenue, preventing the buyer from claiming a double recovery where they keep the cash and also reduce the purchase price.

My recommendation is to define the treatment of deferred revenue explicitly in the LOI. Do not wait for the definitive purchase agreement. Specify that only the direct cost of fulfillment for deferred revenue will be treated as a working capital liability, allowing you to pocket the remaining cash profit at closing.