Cash-free, debt-free enterprise value (CFDF EV) is the headline price for the operating business assuming no excess cash and no interest-bearing debt at closing. Equity value is the money that changes hands. It equals CFDF EV minus net debt, plus or minus a working capital adjustment, and minus any enumerated debt-like items. These items settle at close, so they change how much cash the buyer actually wires.
Think of CFDF EV as a settlement framework. It is not defined by GAAP or IFRS, but by negotiated definitions and schedules in the share purchase agreement. When you align those definitions to your models and comparables, you protect deal economics and reduce post-close disputes.
What CFDF EV is and what it is not
CFDF EV prices the enterprise without excess cash or interest-bearing debt and usually assumes normalized working capital in the plan. That price is then bridged to equity value at closing using the company’s closing balance sheet under the purchase agreement.
CFDF EV is not equity value. Equity value reflects cash, debt, deviations from the working capital peg, and any debt-like items at closing. Earnouts and rollover equity sit outside this math and are typically negotiated separately. CFDF EV is also not a GAAP construct, so the purchase agreement defines how it will be measured and settled.
CFDF EV vs trading comps: keep the bases consistent
Trading-comparable enterprise value and CFDF EV are cousins, not twins. Public trading comps start with market cap and add net debt, preferreds, and minority interests, then subtract investments. CFDF EV is built from balance sheet items that actually settle under the purchase agreement. The two should reconcile, but they diverge when leases, pensions, supplier finance, or minorities are classified differently. If your public trading comps include lease liabilities in enterprise value, decide if the settlement logic will include them too, or add a pro forma EV line for clean multiples.
The bridge from CFDF EV to equity value
In practice the math runs from top to bottom through defined categories. Use the same accounting policies in the peg and the closing statements to avoid apples-to-oranges disputes.
- CFDF EV: Start with the negotiated headline price for the operating business.
- Minus net debt: Deduct closing debt net of closing cash per the defined terms.
- Plus or minus working capital: Adjust for deviations from the working capital peg.
- Minus debt-like items: Deduct enumerated obligations that are neither cash nor working capital.
- Equals equity value: The cash consideration paid at closing.
Anchoring example for clarity
Assume CFDF EV of 500, closing cash of 20, closing debt of 150, a working capital peg of 60, actual working capital of 50, and 5 of debt-like items. Net debt is 130 and the working capital shortfall is 10. Equity value equals 500 minus 130 minus 10 minus 5, or 355. This is your equity check size if nothing else changes.
| Item | Amount |
|---|---|
| CFDF EV | 500 |
| Closing cash | 20 |
| Closing debt (incl. accrued interest) | 150 |
| Net debt | 130 |
| Working capital peg | 60 |
| Actual working capital | 50 |
| Working capital shortfall | 10 |
| Debt-like items | 5 |
| Equity value | 355 |
Mechanics, funds flow, and where disputes arise
The purchase agreement defines cash, debt, and working capital and sets the accounting basis for closing statements. The seller delivers a funds flow showing sources and uses. Lenders fund in parallel, agents discharge liens, and the equity payment nets against uses. For smooth execution, make sure the sources and uses tie to closing debt payoffs and lien releases.
Most post-close disputes come from three gaps. First, definitions that blur the line between debt and working capital create double counting. Second, a peg set on policies that differ from those used at closing invites apples-to-oranges arguments. Third, incomplete schedules of debt-like items, especially tax and employee obligations, create settlement drag and claims.
Cash: define what counts and what does not
Cash is defined, not assumed. Buyers usually include only cash and cash equivalents available for immediate use without restriction, and they exclude items that are not sweepable on day one.
- Restricted balances: Cash pledged to letters of credit or regulatory reserves is not available for settlement.
- Minimum operating cash: Cash trapped in local entities to run operations should be treated as operating, not settlement cash.
- Transit items: Un-cleared deposits or cash in transit do not settle at close.
- Collateral reserves: Insurance collateral and merchant reserves sit outside settlement cash.
Marketable securities and Treasury bills need an explicit call. Either treat them as cash equivalents, which increases the deduction to equity value, or treat them as investments left with the seller. Decide early and mirror your model.
Debt: core items and gray areas to surface early
Debt under CFDF usually includes what must be paid to release liens and to remove financing obligations from the business at close.
- Borrowings and interest: All borrowings under credit facilities, bonds, notes, and overdrafts, plus accrued interest that must be paid at close.
- Leases: Finance leases sit in net debt for settlement. Operating leases are often excluded for settlement even though the cash flows are debt-like. If comps or lenders treat lease liabilities as debt, align the purchase agreement and models to avoid double counting.
- Letters of credit: Drawn letters of credit and bank guarantees are debt. Undrawn facilities are excluded unless drawn or cash-collateralized.
- Supplier finance: Factoring with recourse and securitizations on balance sheet are financing. Supplier finance programs can mask leverage; disclosure rules help diligence, but you still need to test treatment.
Debt-like items reduce equity value and sit outside cash and working capital. Common categories include pension deficits, company-paid transaction fees the target is obligated to pay, earned but unpaid pre-close bonuses and commissions, tax liabilities not captured in working capital, and customer advances when deferred revenue is excluded from working capital. Place each item in one bucket only to avoid double counting.
Working capital and the peg that keeps pricing fair
The working capital adjustment aligns price with a normalized level of operating capital. It removes incentives to starve inventory or stretch payables before close. Two rules make the peg stable and defensible.
- Match definitions: Define working capital to match the ledger used for closing statements. Exclude cash, current debt, and debt-like items. Where possible, list accounts by name and GL code.
- Match policies: Calculate the peg using the same accounting policies applied at closing. If revenue recognition or inventory costing changes, restate the peg.
Supplier finance can inflate payables and working capital. Adjust historical periods to reflect adoption or growth of the program. Do the same for receivables factoring that shortens days sales outstanding. If seasonality is material, set a daily average peg for the 30 to 60 days before close.
Locked-box vs completion accounts: choose the right tool
Locked-box fixes equity price off a historical balance sheet and relies on a strict no-leakage covenant. Completion accounts measure cash, debt, and working capital at closing. Use locked-box when the business is stable, books are clean, and the seller accepts tight leakage terms. Use completion accounts when volatility, seasonality, weak cash control, or unsettled debt-like items complicate accuracy.
Leases, EBITDA, and sale-leasebacks need one logic
Under ASC 842 and IFRS 16, most leases are on balance sheet. Decide upfront whether operating lease liabilities will be treated as net debt for settlement and how EBITDA handles rent add-backs if lease liabilities enter enterprise value. Also specify how to treat sale-leaseback transactions executed between signing and closing, including cash proceeds, gains, and new liabilities.
Derivatives, minorities, investments, and non-operating assets
Mark derivatives to market at closing. Net liabilities increase debt-like items; net assets count only if readily realizable and not pledged. Carve out derivatives that hedge pre-close exposures and settle them at close to avoid post-close P&L noise.
Minority interests and preferred equity that remain outstanding are typically debt-like unless acquired or converted without cash. Equity-method investments are non-operating. Either carve them out or value them separately and keep the comps consistent. Surplus real estate, cash value insurance, related-party loans, and non-core investments sit outside CFDF EV. Either transfer them to the seller or reduce price by their value. Carve-outs create stranded costs, so model the cost-takeout plan and TSA fees and include cost to achieve in equity value.
Documents and execution: nail the playbook
- SPA definitions: The share purchase agreement must define cash, debt, and working capital and include schedules for debt-like items and permitted leakage.
- Funds flow: Align sources and uses, payoff letters, and lien releases to the settlement logic.
- Closing deliverables: Secure payoff letters, security releases, resignations as needed, and officer certificates on cash, debt, and working capital estimates.
- Post-close statements: Prepare per the purchase agreement with a timetable and dispute process, commonly 30 to 90 days.
Fees and tax often swing equity value more than you expect
- Company-paid fees: Company-paid deal fees reduce equity value. Seller-paid fees should be carved out explicitly.
- Change-in-control costs: Pre-close service costs are debt-like. Future-service costs should be buyer obligations post-close.
- Tax leakage: Cash repatriation tax to discharge intercompany balances reduces settlement cash. Exclude trapped cash or adjust enterprise value to reflect leakage and approvals.
Reporting consistency and model alignment
Align the model, comps, and purchase agreement so lease treatment, net debt settlement, and EBITDA definitions use one logic. Tie adjusted metrics to audited figures and ensure your debt schedule matches the payoff mechanics. If comps include lease liabilities in EV, include them in settlement or show a pro forma EV line. For earnings transparency, reconcile adjustments with an earnings bridge and link the logic into your three-statement model.
Risks and edge cases that merit extra diligence
- Supplier finance: Reverse factoring can inflate working capital or mask leverage. Reset the peg if program size changed.
- Receivables financing: Factoring with recourse is financing in substance and should be treated as debt.
- Lease-backed deals: Clarify treatment for sale-leasebacks near closing, including proceeds and liability handling.
- Pensions: Lock remeasurement assumptions and dates to avoid volatility between peg and close.
- Foreign controls: Exclude trapped cash unless upstreaming is clearly legal and practicable.
- Related-party terms: Normalize off-market pricing that distorts margins and working capital.
Kill tests for fast triage
- Excess leverage: If net debt including leases and supplier finance exceeds CFDF EV, reset price or restructure obligations before proceeding.
- Program changes: If supplier finance or factoring changed materially in the last year, freeze the peg and restate the base before signing.
- Trapped cash: If more than one third of “cash” is restricted or under capital controls, exclude it from settlement or reduce enterprise value.
- Volatile liabilities: Treat large pension or environmental provisions as debt-like with locked measurement and protection such as indemnity or escrow.
- Unclear lien release: If the seller cannot deliver a funds flow that clears all liens on closing debt, reprice or walk.
Presenting CFDF EV without losing the room
- Bridge first: Start with CFDF EV and show a one-line bridge for each defined term to equity value. Keep debt-like items separate from working capital.
- Comparable logic: Match comp-set EV to your settlement logic. If leases are in comps, include them in net debt or show a pro forma EV line with a consistent EBITDA definition.
- Cash clarity: Disclose which cash is excluded from settlement and why. Show trapped cash separately for lender diligence.
- Funding certainty: Tie funds flow to financial close and confirm the equity check covers the worst-case working capital shortfall and debt-like items identified in diligence.
Drafting moves that cut disputes
- List by GL code: List working capital accounts by GL code and avoid catch-all buckets.
- Define cash tightly: Address restricted cash, transit items, and securities explicitly in the purchase agreement.
- Expose supplier finance: Require disclosure of program size, terms, and balances at closing and state whether balances sit in working capital or net debt.
- Pin down leases: State whether operating lease liabilities are in net debt and how sale-leaseback proceeds and modifications are handled between signing and close.
- Lock the peg basis: Fix the peg on the same policies used for closing statements. If policies change, require a restated peg.
When lenders and CFDF do not line up
If lenders underwrite higher closing net debt than your CFDF model assumes, bridge early. Increase rollover equity or vendor financing to reduce cash at close. Use escrow against specific debt-like items that need more diligence. Align lease treatment with lender leverage metrics. If operating leases are in lender leverage, include them in net debt and adjust EBITDA. Finally, seasonality matters, so adjust the working capital peg for the close date or use a daily average near closing.
When CFDF is the wrong tool
CFDF EV loses utility in structurally negative working capital models if most liabilities sit in working capital by definition. In those cases, price the business on sustainable cash flow and settle specific balance sheet items separately. CFDF also struggles in distress, where recoveries depend on debt terms rather than neat cash and debt definitions, and in project finance, where ring-fenced leverage and contracted cash flows dictate enterprise value. If earnouts will carry meaningful value in volatile cases, structure them deliberately and align metrics at signing. For more on structuring, see earnout provisions.
Closing Thoughts
Treat CFDF EV as a settlement framework, not scripture. Make choices explicit and consistent. Tie EBITDA definitions, lease treatment, and net debt settlement to the same logic used in comps and lender metrics. Spend the most time where equity value moves after signing: the working capital peg, supplier finance, leases, and the debt-like schedule. Demand a funds flow that clears liens and maps tax leakage. Your equity check depends on it.