During our sell-side Quality of Earnings preparation, the accounting firm is flagging that our accrued bonuses and customer prepayments are being double-counted as both debt-like items and working capital adjustments. How do we establish a clear line of demarcation to prevent the buyer from clawing back our cash at close?

Question

Tyler Smith · Accepted Answer

Double-counting assets and liabilities is a classic buyer tactic used to reduce the cash you receive at closing. During a Quality of Earnings review, the buyer's team will try to classify customer prepayments or deferred revenue as debt-like items. This means they expect you to leave cash behind to cover those obligations, while simultaneously excluding those same prepayments from your net working capital calculation.

To prevent this financial erosion, you must establish a clear line of demarcation in your Letter of Intent and definitive purchase agreement. The rule of thumb is that any balance sheet item must be treated as either a debt-like item or a working capital component, but never both. If deferred revenue is treated as working capital, it must be included in both the historical working capital peg and the closing working capital calculation.

This approach ensures a dollar-for-dollar adjustment that preserves your cash. Use your monthly financial reviews to detail exactly how these prepayments are recognized and spent. Your finance seat on the Accountability Chart must present a detailed schedule showing that these prepayments are backed by actual, repeatable work that does not require extraordinary cash outlays post-close.

By presenting this data during the sell-side Quality of Earnings phase, you can define these terms before the buyer writes their first draft of the purchase agreement. This defensive accounting strategy ensures you do not pay twice for the same operating liability.