Debt-Like Items: Why the Equity Cheque Is Never Just Enterprise Value Minus Net Debt
Michael King, PE Investment Manager · 9 min read ·
- A deal is struck on enterprise value — a multiple of EBITDA — but sellers are paid equity value, and the bridge between the two is net debt plus a list of debt-like items, not simply gross debt minus cash
- The debt-like list is longer than most candidates think: pension deficits, capitalised lease liabilities (IFRS 16), minority interest, preferred equity, deferred consideration and earn-outs, and certain provisions all reduce the equity cheque. Cash-like items — surplus cash, investments in associates, tax assets — increase it
- The single most common trap is IFRS 16 leases: whether the lease liability is a debt-like deduction depends entirely on whether the EBITDA the multiple was applied to was struck pre- or post-IFRS 16. Mismatch the two and you double-count or omit the leases entirely
- On a mid-market deal, getting the list wrong routinely swings the equity value by 10–30% — which is why net debt is not calculated on a spreadsheet and accepted; it is negotiated line by line, with each side arguing what is and is not “debt-like”
Enterprise Value Is the Price; Equity Value Is the Cheque
A buyer and seller agree a headline number early — say ten times EBITDA — and that number is an enterprise value: the value of the business itself, to every provider of capital, independent of how it is financed. But nobody wires enterprise value to anyone. The sellers own the equity, so what they are actually paid is equity value — enterprise value after everyone with a claim ranking ahead of the ordinary shareholders has been settled. The entire second half of a deal is a fight over the bridge between those two numbers, and that fight is worth far more than most candidates realise.
Ask an interviewee to get from enterprise value to equity value and the reflex answer is “subtract net debt — gross debt minus cash.” That is the textbook debt-stack answer, and it is incomplete. Net debt is only the first line of a longer schedule of debt-like items: obligations that are not labelled “loan” on the balance sheet but that a buyer must nonetheless assume or settle, and therefore refuses to pay for twice. Leave them out and you have overpriced the equity, sometimes grossly.
The Full Bridge, Worked
Take a business agreed at an enterprise value of £500M — ten times £50M of EBITDA. The naive bridge stops at net debt. The real one keeps going:
| Line | Amount | Running equity value |
|---|---|---|
| Enterprise value (10 × £50M EBITDA) | £500M | £500M |
| Less: net debt (gross debt £180M − cash £30M) | −£150M | £350M |
| Less: pension deficit (net of deferred tax) | −£15M | £335M |
| Less: capitalised lease liabilities (IFRS 16) | −£35M | £300M |
| Less: minority interest | −£20M | £280M |
| Less: preferred equity | −£15M | £265M |
| Less: deferred consideration / earn-out payable | −£10M | £255M |
| Plus: investment in associates | +£10M | £265M |
The £350M answer is not a rounding error away from £265M; it is a different deal. Work through each line below net debt, because each is a place candidates lose the number.
Pension Deficits: A Debt the Company Cannot Refinance Away
A defined-benefit pension scheme in deficit — assets worth less than the promised liabilities — is a claim that must be funded out of future cash, exactly like debt. Buyers treat the net deficit as debt-like and deduct it. Two refinements separate a clean answer from a rote one. First, the deficit is usually taken net of the deferred tax asset it generates: a £20M gross deficit at a 25% tax rate is roughly £15M of real economic drag, because the future contributions are tax-deductible. Second, the number to use is the funding or buy-out deficit the trustees will actually chase, not the accounting IAS 19 figure, and the two can differ by a wide margin. Naming that distinction signals you have seen a real deal rather than a textbook.
IFRS 16 Leases: The Trap Is Consistency, Not the Number
Since IFRS 16, almost every lease sits on the balance sheet as a right-of-use asset and a matching lease liability. That liability looks debt-like — it is a fixed future obligation — and the instinct is to deduct it in the bridge. Sometimes that is right. Sometimes it double-counts. The deciding question is not about the lease at all; it is about the EBITDA the multiple was applied to.
This is the item interviewers probe hardest now, precisely because it has no fixed answer. The right response is a question back: “Is the EBITDA pre- or post-IFRS 16?” Get that straight and the lease treatment follows automatically. Get it wrong and a £35M error walks silently into the equity value, as it does in the table above if the leases are handled inconsistently.
Minority Interest, Preferred Equity and the Ranking Order
The remaining big-ticket lines are claims that sit between the enterprise and the ordinary shareholder. Minority interest is the slice of a consolidated subsidiary the company does not own: because EBITDA consolidates 100% of that subsidiary’s earnings, the enterprise value implicitly bought 100% of it, so the minority’s share of value must be handed back before reaching equity. Preferred equity ranks ahead of the ordinary shares by contract — a fixed claim on proceeds — so it too is deducted. Both are debt-like in the only sense that matters here: someone other than the ordinary shareholder has first call on part of the enterprise value.
The mirror image is investments in associates and other non-core or surplus assets. Associate earnings sit below the operating line and are not in EBITDA, so their value was never captured in the ten-times multiple; it is added back as a cash-like item. The logic is the same rule read forwards and backwards: if the earnings are in the metric, the claim is in the bridge; if the earnings are out, the asset is added separately.
The Long Tail: Earn-Outs, Provisions and Debt-Like Working Capital
Below the headline lines sits a long tail that is where deals are actually won and lost in diligence. Deferred consideration and earn-outs from the target’s own past acquisitions are future cash the buyer inherits — debt-like. So are onerous-contract provisions, restructuring provisions, and unpaid tax or dividends declared but not yet paid. Then there is the greyest category of all: debt-like working capital. If the target has stretched its suppliers or pulled receivables forward to flatter cash at completion, the “normal” working capital the buyer expected is lower than the snapshot suggests, and the shortfall is treated as debt. This is precisely the ground a quality-of-earnings review is commissioned to police, and precisely why the net-debt schedule is contested rather than agreed.
The Verdict: Net Debt Is Negotiated, Not Calculated
The lesson underneath the mechanics is that “net debt” is not a figure that falls out of the accounts. Every line below gross-debt-minus-cash is a judgement, and every judgement moves the equity cheque pound for pound. Is the pension deficit measured on an accounting or a buy-out basis? Are the leases in the EBITDA or in the bridge? Is a provision a real liability or an accounting cushion the seller will argue is non-cash? Is working capital at completion “normal” or dressed? Each of these is a negotiation, run through the completion-accounts or locked-box mechanism, and the aggregate of them routinely moves the price by more than the buyer and seller spent months arguing about the multiple itself.
The candidate who says “equity value equals enterprise value minus net debt” has the shape right and the substance missing. The one who says “minus net debt and the debt-like items — pensions net of tax, leases if the EBITDA is post-IFRS 16, minority interest, preferred, earn-outs and any debt-like working capital — and by the way each of those is a negotiation, not a given” is describing the job. The bridge is not arithmetic bolted onto a clean number. It is the deal.
Take Your Preparation Further
The debt-like bridge sits at the join between valuation and deal execution, so read it alongside both. Start with the fundamentals in the enterprise-to-equity value bridge; see where the debt itself is built in the LBO debt stack; understand how the working-capital and provisions lines get scrubbed in quality of earnings and EBITDA add-backs; and see how the whole net-debt figure is fixed at completion in locked box versus completion accounts. For the cash-flow lens on why leases and pensions are real claims, work through EBITDA to free cash flow.
For the full bridge on one page — every adjustment, every sign, with worked model answers — download the free EV Bridge Cheat Sheet, and for comprehensive technical interview preparation across valuation and deal mechanics, see the IB Interview Bible.
Ready for personalised feedback? Book a 1-on-1 mentoring session with an experienced IB/PE professional.
Frequently asked questions
What counts as a debt-like item in the enterprise-to-equity value bridge?
Beyond ordinary net debt (gross financial debt minus cash), the standard debt-like items deducted from enterprise value to reach equity value are: underfunded pension deficits (usually net of the associated deferred tax), capitalised lease liabilities under IFRS 16 (only if the EBITDA used was struck post-IFRS 16), minority interest, preferred equity, deferred consideration and earn-outs payable, onerous-contract and restructuring provisions, declared-but-unpaid dividends and unpaid tax, and any debt-like shortfall in working capital versus its normalised level. Cash-like items — surplus cash, investments in associates, and certain tax assets — are added rather than deducted.
Why isn’t net debt just total debt minus cash?
Because a buyer must assume or settle every obligation that ranks ahead of the ordinary shareholders, not only the items labelled “loan” on the balance sheet. A pension deficit, a lease liability, an earn-out owed from a past acquisition, or a provision for an onerous contract are all future cash obligations the buyer inherits, so they are treated as debt-like and deducted from enterprise value. Total debt minus cash captures only the financial borrowings; the debt-like schedule captures everything else with a prior claim, and on a mid-market deal it can move the equity value by 10–30%.
How are IFRS 16 lease liabilities treated in the bridge?
It depends entirely on the EBITDA the multiple was applied to. Post-IFRS 16, rent is stripped out of operating costs and split into depreciation and interest, so EBITDA is higher. If the valuation multiple was applied to that post-IFRS 16 EBITDA, the lease liability is genuinely debt-like and must be deducted in the bridge. If the multiple was applied to a pre-IFRS 16 EBITDA that still contained the rent expense, deducting the lease liability as well double-counts it. The rule: the leases belong either in the earnings or in the bridge, never both and never neither — so always confirm whether the EBITDA is pre- or post-IFRS 16 first.
Is a pension deficit deducted at its gross or net figure?
Usually net of the deferred tax asset it creates. Future pension contributions are tax-deductible, so a gross deficit of, say, £20M at a 25% tax rate represents roughly £15M of real economic drag. A further refinement is which deficit to use: the accounting IAS 19 figure that appears in the statements can differ materially from the funding or buy-out deficit the pension trustees will actually pursue, and it is the latter that a buyer cares about. Naming both the tax treatment and the funding-versus-accounting distinction is what separates a practised answer from a memorised one.
Why do buyers and sellers negotiate net debt rather than just calculate it?
Because almost every line below gross-debt-minus-cash is a judgement call, and each one shifts the equity cheque pound for pound. The parties argue over whether a provision is a genuine liability or a non-cash accounting cushion, whether a pension deficit should be measured on an accounting or buy-out basis, whether leases sit in the EBITDA or the bridge, and whether working capital at completion is “normal” or has been flattered by stretching suppliers or pulling receivables forward. These are settled through the completion-accounts or locked-box mechanism, and in aggregate they frequently move the final price by more than the negotiation over the headline multiple did.