One of the main parameters affecting the determination of a company’s value is its financial debt. Most acquisition operations are established on a cash free, debt free basis. Thus, for the purposes of determining the price, the price is established on the basis of current profits from which the financial debt is subtracted.
Generally speaking, the debt items deducted from the price correspond to interest bearing debt, which is typically bank debt, net of cash and other liquid items. In addition to bank debt, other items that can be assimilated to financial debt must be considered. These should include, among others, deferrals from the tax authorities, debt related to investments, related companies or current suppliers not paid on maturity. All these concepts must be well analysed since they may alter the financial position of a company by hiding a higher level of financial debt. The seller could, for example, delay payment to suppliers in order to reduce their bank debt and obtain a higher price for the company.
Debt and letter of internet
The previous agreements reached between the buyer and seller are set out in the Letter of Intent, a document which sets out the conditions and basis on which the transaction will take place. The lack of a single definition of financial debt, it requires special attention in the Letter of Intent. It is essential to determine the level of debt expected at the closing of the transaction and the concepts that will be considered. Examples and hypothetical estimates can provide clarity.
A company acquisition requires a large deployment of internal and external resources and access to confidential and strategic information. In the interest of the parties, the items should be clearly defined in the letter of intention, thus avoiding problems at the final moments that will endanger the transaction.
A company’s financing needs and debt level depend on the seasonality of the business and its working capital structure (levels of customers, stocks, suppliers, etc.). The fluctuation of these items affects the evolution of the financial debt, and their analysis must be covered during the due diligence process. The due diligence team will focus part of its work on determining the working capital levels of the business, as well as identifying and quantifying the financial debt.
So, there is no single definition of financial debt. Due to its significant relevance in the determination of the price, its definition and content must be established between the parties negotiating a transaction. The subsequent analysis and quantification of the debt must be carried out within the framework of due diligence.