Definition
Cash-free, debt-free is a basis for pricing a business as if it had no cash in the bank and no borrowings on the day it changes hands. The seller keeps any surplus cash, repays loans out of the proceeds and leaves behind a normal level of working capital so the business can keep trading. It matters most in a share sale (stock sale in the US), where the company's bank balances and loans would otherwise pass to the buyer with it.
Working capital is the money tied up in running a business day to day, mainly stock and money owed by customers, less money owed to suppliers. A sale needs to agree how much of it comes with the business.
In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.
Worked example
Tallowmere Signs Ltd is a fictional UK company sold for £2,000,000 on a cash-free, debt-free basis. At completion it holds £300,000 of cash and owes £500,000 on a bank loan.
- The £300,000 of cash is added to the price, giving £2,300,000.
- The £500,000 loan is deducted, so the price for the shares is £1,800,000, before any working capital adjustment.
At completion you pay the seller £1,800,000 and fund repayment of the £500,000 loan, an outlay of £2,300,000. You receive a company with £300,000 of cash and no bank debt, so the net cost is the agreed £2,000,000.
Why buyers care
The headline price is only the start. What you finally pay depends on how cash and debt are defined, and those definitions are negotiated.
Overdrafts, finance leases, unpaid tax, loans from the owner, customer deposits and overdue supplier bills may or may not be treated as debt. Anything left out becomes your cost after completion. Cash that is not really free, such as customer money held for future orders, should not be paid for as surplus cash.
Agree these definitions in principle in the letter of intent (heads of terms in the UK), then ask your accountant and lawyer to check the wording in the purchase agreement.
A letter of intent sets out the main terms on which a buyer proposes to acquire a business, before due diligence and the full purchase agreement. In the UK the equivalent is usually heads of terms.
Heads of terms is the UK name for a short document recording the main commercial terms of a deal before the legal documents are drafted. It is the equivalent of a US letter of intent.