Cash-Free, Debt-Free Explained: Why the Buyer Agrees Enterprise Value but Writes a Smaller Cheque — the Net-Debt Deduction, the Working-Capital Peg, and the True-Up That Moves the Price Pound-for-Pound
Michael King, PE Investment Manager · 9 min read ·
- "Cash-free, debt-free" is the standard basis for pricing a private company: the buyer acquires the operating business as if it held no cash and carried no borrowings, so enterprise value — not the equity price — is what gets agreed on the multiple
- The seller keeps surplus cash and repays existing debt out of the sale proceeds, which is why the actual equity cheque is enterprise value minus net debt, before working capital is even considered
- The second adjustment is a working-capital peg: the buyer expects a normal level of working capital to come with the business, and the price moves pound-for-pound for whatever is delivered above or below that target — the peg is usually a trailing average, set that way to strip out seasonality and stop either side timing the balance sheet
- The equity price = enterprise value − net debt ± (delivered working capital − the peg); a £500m headline can become a £375m cheque without a single term being renegotiated
The Multiple Prices the Business, Not the Balance Sheet Around It
When a buyer agrees "10x EBITDA" for a private company, they are pricing the operating business — its ability to generate cash — not the particular pile of cash sitting in its bank account or the loans it happens to carry on the day of signing. Those items belong to the current owner and have nothing to do with what the business is worth. The convention that separates the two is cash-free, debt-free (CFDF): the buyer buys the company as if it had zero cash and zero debt, and the seller deals with both out of the proceeds.
The number that convention fixes is enterprise value — the value of the operating business, independent of how it is financed. That is why the press release quotes an enterprise value and why the multiple is struck against it. What the seller actually receives is a different number, and getting from one to the other is the entire point of the CFDF mechanic.
Adjustment One: Net Debt Comes Straight Off the Price
On a CFDF basis the seller is responsible for clearing the company's borrowings at completion, and does so out of the money the buyer pays. In practice the mechanics net off: the buyer agrees enterprise value, deducts the target's net debt — gross borrowings less surplus cash — and pays the balance as equity value. The debt is either repaid at closing from the proceeds or refinanced by the buyer, but either way it reduces what lands in the seller's pocket pound-for-pound.
"Net debt" is where the first fight happens, because the definition is negotiated, not given. Bank loans and bonds are obvious. Less obvious — and heavily contested — are the debt-like items: pension deficits, unpaid deferred consideration from earlier deals, unfunded capex commitments, corporation tax owed, finance leases. Each one a buyer can characterise as debt is another pound off the equity price, which is exactly why the SPA hard-codes a defined net-debt list rather than leaving it to argument. The same items a Quality of Earnings report flags as below-the-line are the ones that resurface here as real money.
Adjustment Two: The Working-Capital Peg, and Why It Is an Average
The second adjustment is subtler and catches more candidates out. CFDF strips the cash and the debt, but the business still has to change hands with enough working capital to keep running — a buyer taking over a company with its receivables collected, its inventory sold and its payables left unpaid would be inheriting an empty tank and would have to fund the refill on day one. So the buyer expects a normal level of net working capital to be delivered with the business, and the two sides agree that normal level in advance: the working-capital peg (or target).
The price then trues up against the peg pound-for-pound. Deliver more working capital than the peg and the seller is handing over extra net assets, so the price goes up by the excess; deliver less and the price comes down by the shortfall. The logic is symmetrical and mechanical, and it exists to stop the seller stripping the business of its working capital in the run-up to completion — chasing every receivable, running down stock, stretching every payable — to flatter the cash that gets swept out under the debt-free leg.
A Worked Bridge: How £500m of Enterprise Value Becomes a £375m Cheque
Keep the numbers round so the mechanics stay visible. A business does £50m of EBITDA and is bought at 10x, so enterprise value is £500m. It carries £120m of net debt. The agreed working-capital peg is £40m, and the completion balance sheet delivers £35m.
Where the Money Actually Moves: the Definitions, Not the Formula
The formula — equity value equals enterprise value minus net debt, plus or minus the working-capital adjustment — is trivial. The value moves in the definitions underneath it, and both sides know it. On the debt-free leg, every item a buyer can push into the net-debt list drops the price; on the working-capital leg, how the peg is calculated and what counts as working capital decide the true-up. This is why the sale-and-purchase agreement spends more pages on defining net debt and normalised working capital than on almost anything else, and why the accounting policies used to draw up the completion balance sheet are negotiated line by line.
The timing of when these numbers are fixed is itself a choice — measure them at a historical date before signing and lock the price, or measure them at completion and true up afterwards. That choice is the subject of locked-box versus completion accounts, and CFDF is the arithmetic that sits inside whichever mechanism the parties pick: a locked-box fixes the net-debt and working-capital position at the box date and pays a fixed equity price off it, while completion accounts leave the CFDF adjustments open and settle them in a post-close true-up.
| Item | Whose it is under CFDF | Effect on the equity price |
|---|---|---|
| Surplus cash | Seller keeps it (swept out before or at close) | Raises net cash, so raises the equity price |
| Bank debt & bonds | Seller repays from proceeds | Deducted pound-for-pound |
| Debt-like items (pensions, deferred consideration, unpaid tax) | Negotiated — buyer pushes to include | Each item included drops the price |
| Working capital vs peg | Delivered with the business | Above peg raises price; below peg cuts it |
The Follow-Ups That Separate a Definition From a Deal
"What does cash-free, debt-free mean?" is the opener; the follow-ups check whether you have priced one. Three come up repeatedly.
"Why is the working-capital peg an average and not the closing balance?" Because a single date is both seasonal and gameable. A trailing-twelve-month average smooths the seasonal swing and removes the incentive to time the balance sheet — chase receivables and delay payables into the final week to lift the delivered figure — since the peg it is measured against is built on the same normalised basis. A single-month peg struck at a seasonal low hands the seller a structural windfall on every deal that completes after the low point.
"How does CFDF interact with the equity the sponsor funds?" Directly. The equity cheque a private equity buyer writes is the CFDF equity value, not the headline enterprise value, so the net-debt and working-capital adjustments feed straight into the sources and uses and the returns. A £5m adverse working-capital true-up is £5m more of sponsor equity, and on a deal with a thin equity cheque that moves the entry ownership and the IRR more than the headline suggests. This is why the deal team, not just the lawyers, owns the net-debt list and the peg.
What the Question Is Actually Testing
Cash-free, debt-free looks like vocabulary and is really about whether you understand that a business is worth its operating cash flows, and that everything else on the balance sheet is a separate settlement between the current owner and the buyer. The candidate who can bridge enterprise value to the equity cheque — deduct net debt, name the debt-like items that get argued over, apply the working-capital peg and explain why it is an average — has demonstrated the one skill the mechanic is built to test: pricing a real deal rather than reciting a headline. Read the CFDF adjustments as where the negotiation actually happens, not as arithmetic after the fact, and the follow-ups mostly answer themselves. For the judgement that sits above the mechanic — when enterprise value is even the right basis to argue over — see how to think about valuation.
Take Your Preparation Further
CFDF is the join between valuation and deal execution, so read it against the pieces on either side. Start with the EV-to-equity value bridge for the formula CFDF sits inside, then debt-like items and the net-debt bridge for the definitions that decide how much comes off the price. For when the adjustments are fixed and trued up, locked-box versus completion accounts; for where the disputed items are first flagged, Quality of Earnings and EBITDA add-backs; and for where the equity cheque it produces gets funded, the sources and uses table and the LBO model.
For a component-by-component reference on every adjustment from enterprise value to equity value, download the free Enterprise Value Bridge Cheat Sheet, and for the model that turns the CFDF equity cheque into a returns analysis, the LBO Model Template.
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Frequently asked questions
What does "cash-free, debt-free" actually mean in an M&A deal?
It is the standard basis on which a private company is priced. The buyer acquires the operating business as if it held no cash and carried no borrowings, and the seller deals with both out of the proceeds — sweeping out surplus cash and repaying existing debt at completion. Because cash and debt belong to the current owner and have nothing to do with what the business is worth, this convention lets the buyer price the business itself on a multiple, agreeing an enterprise value rather than an equity value. The equity price the seller actually receives is then derived from that enterprise value by deducting net debt and adjusting for working capital.
How do you get from enterprise value to the equity price under CFDF?
Start with the enterprise value agreed on the multiple, deduct net debt — gross borrowings less surplus cash, plus any negotiated debt-like items such as pension deficits, deferred consideration or unpaid tax — and then apply the working-capital adjustment: the price rises pound-for-pound for working capital delivered above the agreed peg and falls for anything below it. So equity value equals enterprise value minus net debt, plus or minus (delivered working capital minus the peg). On a business bought at £500m enterprise value with £120m of net debt and £5m of working capital delivered below a £40m peg, the equity cheque is £375m — a 25% gap to the headline, driven entirely by the CFDF adjustments.
What is a working-capital peg and why is it a trailing average?
The peg, or target, is the normal level of net working capital the buyer expects to come with the business so it can keep operating from day one without funding a refill. The final price trues up against it pound-for-pound — deliver more and the seller is paid for the excess, deliver less and the price is cut. It is almost always set as a normalised level, typically the average of the last twelve months, rather than a single month-end figure, because a single date is both seasonal and gameable: a retailer's working capital after Christmas looks nothing like its position when the shelves are stocked. A trailing average strips out that seasonality and removes the incentive to time the balance sheet by chasing receivables and stretching payables into the final week.
Why does the enterprise value in a press release differ from what the seller receives?
Because the announced figure is the enterprise value — the price of the operating business — while the seller receives equity value, which is enterprise value minus net debt and adjusted for working capital. Under cash-free, debt-free, the target's borrowings are repaid out of the proceeds and its surplus cash is swept out separately, so on any levered business the equity cheque sits below the headline, sometimes by a quarter or more. Quoting the enterprise value as the amount the seller got is the same error as confusing enterprise value with a share price: it skips the net-debt and working-capital steps that convert the headline into the money that actually changes hands.
How does the CFDF adjustment affect a private equity buyer's equity cheque?
The equity a sponsor funds is the CFDF equity value, not the headline enterprise value, so the net-debt and working-capital adjustments feed straight into the sources and uses table and the returns. Every debt-like item the buyer includes and every pound of working capital delivered below the peg increases the equity the sponsor has to write, pound-for-pound. On a deal with a thin equity cheque that shifts the entry ownership and the IRR more than the size of the adjustment suggests, which is why the deal team — not only the lawyers — owns the net-debt definition and the working-capital peg, and models the adjustments into the equity bridge rather than treating them as a post-close afterthought.