The buyer demands our business be delivered cash-free and debt-free, but we have significant outstanding equipment leases and vehicle financing. How do we determine which liabilities must be paid off at close and which can be transferred to the buyer as operational debt?

Question

Tyler Smith · Accepted Answer

The phrase cash-free, debt-free sounds simple, but it is a frequent source of late-stage transaction disputes. Lenders and buyers define debt broadly, and they will try to classify any interest-bearing liability, including equipment leases and vehicle financing, as debt that you must pay off from your proceeds at close.

To resolve this, you must separate capital leases from operating leases. Capital leases are essentially funded debt used to purchase assets, and buyers will almost always require them to be paid off at close. Operating leases, however, are ongoing operational expenses and should remain with the business as part of normal operations.

You must negotiate these definitions during the LOI stage, not during final legal drafting. Have your finance seat review every lease agreement and classify them clearly.

For equipment that is critical to daily operations, argue that these leases are part of the normal working capital cycle. If the buyer forces you to pay them off, they are receiving the equipment free and clear, which effectively increases the value of what they are acquiring without paying you for it.

Use your structured Thinking Time to analyze the financial impact of paying off these leases. If you must pay them off, negotiate a corresponding increase in the working capital peg to ensure you are compensated for the equity you are leaving in the business.