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What items to include in a debt & debt-like schedule?

The whole point of the debt and debt-like schedule is to flag items that are 3rd party debt with creditors, as well other items that should be considered debt. As you can see in the visual below, cash and debt items impact the overall purchase price paid by the buyer in an M&A transaction.

As part of financial due diligence, the FDD team will prepare the debt & debt-like analysis. The schedule below is an example of what a debt & debt-like schedule will look like:

Net debt or Net Cash

Since most M&A transactions are debt-free and cash free, its important to identify total 3rd party debt (with outside creditors), as well as a company’s reported cash and cash equivalents (included restricted cash).

If the transaction is not debt-free and cash-free, then and debt and debt-like items will reduce the purchase price and cash will increase the purchase price. Both of these items are excluded from the calculation of enterprise value.

What are some examples of debt-like items?

The list is endless and there is no way to capture all the possible debt-like items that you could encounter in a deal. However, below is a list of common items that you are more likely to see in a transaction:

1) Non-recurring or unusual items: This may relate to recent initiatives or items specific to the transaction. Examples include retention bonuses, spot bonuses, restructuring reserves, etc.

2) Income tax liabilities: Since income taxes are excluded from EBITDA in the QoE analysis and any income tax liabilities are removed from net working capital, then income tax liabilities should be included in the debt-like schedule.

3) Unpaid transaction costs: The Seller will often have accrued transaction fees on the balance sheet or off-balance sheet that relate to the current transaction. These unpaid transaction costs should be paid by the seller and not by the buyer.

4) Legal liabilities: The seller may have specific legal liabilities that are accrued on the balance sheet. These may relate to transaction legal fees or non-recurring legal fees. If the seller added back legal expenses in the QoE, then any accrued legal liabilities on the balance sheet should be removed from NWC and added to the debt-like schedule.

5) Environmental obligations: While it will be difficult to get the Seller to pay the buyer for this potential liability, it is worth highlighting, especially if the buyer things there will be fees to remediate the environmental liability in the near future.

6) Change in control provisions: Certain executives or employees may be entitled to a bonus if ownership of the company changes. It is very common for the CEO to have this provision in their employment agreement. Additionally, there could be change in control provisions with suppliers or customers that should be flagged as a potential debt-like item.

7) Aged payables: If the company has certain payables that are extremely overdue (60 or 90 days+) and they have been removed from NWC, then they should be added to the debt-like schedule.

8) Tax exposure: The company may have tax exposures that are not recorded on the balance sheet. For example, some companies will have sales tax issues, employment tax issues, or foreign tax issues. Typically, the FDD team will engage M&A tax to help evaluate if there are any material tax exposures.

9) Insurance IBNR: The buyer should assess whether the IBNR reserve on the balance sheet is reasonable. There is a good chance that the seller does not have a conservative estimate, which could result in a future cash outflow for the buyer post-transaction.

10) Outstanding purchase price obligations (i.e. earn-outs): If the seller was engaged in other recent M&A transactions, then there could be earn-outs that are still active. For example, if the company made an acquisition earlier in the year, the company could still be on the hook for earn-outs for the foreseeable future. The buyer should try to get any earn-outs added to the debt-like schedule.

11) Early contract termination payments: As part of the current transaction, the company may have to terminate certain contracts. For example, they may have a lease agreement that will have to be terminated because there are synergies from the business combination. If there is an early termination fee, then this should be added to the debt-like schedule. Other examples include prepayment of debt or other liabilities.

12) Restricted cash: Restricted cash is included in the cash & cash equivalents balance in reported net debt or cash. However, since the cash is restricted, the buyer will have to fund the restricted cash requirement if the seller does not leave the cash behind.

What are some examples of commitments and contingencies?

While these are typically not included in the debt-like schedule, they should be included in the debt & debt-like schedule so that the buyer is aware of these future liabilities. Some examples include:

1) Operating leases: This is the most common example and can typically be obtained from the company’s audited financial statements. Capital leases would be reported in net debt.

2) Letters of credit: Letters of credit guarantee a creditor or another party cash from the company if a customer or vendor default. If there is an expectation that the company will have to pay the cash, then it should be included as a debt-like. If there is no expectation of default, then it should be highlighted in this section.

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