In our draft purchase agreement, the buyer classifies our accrued employee bonuses, unpaid paid-time-off, and sales tax reserves as indebtedness instead of normal operating liabilities in working capital. Why are they doing this, and how do we negotiate the line between working capital and debt-like items?

Question

Tyler Smith · Accepted Answer

Buyers classify accrued liabilities as indebtedness rather than working capital because indebtedness triggers a dollar-for-dollar reduction from the cash delivered to you at closing. In contrast, normal working capital liabilities are absorbed into the working capital peg, which only impacts your net proceeds if net working capital falls short of an agreed historical average.

To protect your cash at close, establish clear definitions in the definitive purchase agreement:

- Accrued payroll and standard employee paid-time-off are ordinary recurring operational expenses. If historical working capital calculations always included these accrued liabilities, they must remain in current liabilities within the net working capital peg. Removing them and labeling them as debt creates double counting in the buyer's favor.
- Sales tax reserves, unresolved customer disputes, or legacy audit assessments represent true contingent liabilities. If the buyer demands that tax reserves be treated as debt-like items, require that any unused reserves be returned to you in cash upon the expiration of the statutory audit period.
- Separate transaction-specific expenses from everyday operations. Transaction bonuses, legal fees for your M&A team, and change-of-control severance payments are true company transaction expenses and belong in closing indebtedness. Everyday performance bonuses earned under a standard annual incentive plan should remain inside working capital.

Walk through every line item on your balance sheet with your deal counsel before accepting the final definitions of Indebtedness and Net Working Capital. Ensuring that ordinary operational obligations sit inside the working capital peg preserves your liquidity and stops the buyer from chipping away at your headline valuation.