The buyer proposed a cash-free, debt-free LOI, but their draft definitions treat our annual employee bonuses, customer prepayments, and equipment operating leases as debt deductions from our closing cash. How do we draw a clear line between working capital and debt-like items before signing the LOI?

Question

Tyler Smith · Accepted Answer

The phrase cash-free, debt-free is dangerous because the definition of debt is where buyers extract millions in backdoor price cuts. You must define debt-like items and current liabilities explicitly in the LOI, rather than waiting for the definitive purchase agreement.

Operating working capital covers the short-term assets and liabilities required for normal day-to-day business operations. Accounts payable, standard payroll accruals, and operating expenses belong strictly within the Net Working Capital calculation. If an item is inside the working capital peg, it cannot also be deducted as debt. That would allow the buyer to double-dip on your balance sheet.

Annual employee bonuses must be handled based on historical accrual norms. If bonuses are paid periodically as an ongoing operational expense, they belong in working capital. Agree in the LOI that bonus liabilities will be prorated through the closing date and included in the working capital peg, not deducted dollar-for-dollar as funded indebtedness.

For customer prepayments and deferred revenue, resist debt-like treatment unless there is an abnormal cash collection surge without matching fulfillment inventory.

For operating leases, ensure the LOI specifies that GAAP operating leases under standard ASC 842 rules remain operational commitments rather than debt obligations. Only capital leases or equipment purchase debt should reduce cash at close.

Define these categories explicitly in an exhibit attached to your LOI. Never sign an LOI with vague debt definitions assuming transaction attorneys will resolve it later.