Glossary
Net Debt and Debt-Like Items
Transaction net debt is agreed borrowings and debt-like obligations, less qualifying cash. In a cash-free, debt-free acquisition, it is part of the bridge from enterprise value to equity value. The agreement determines what is repaid, assumed or deducted from proceeds.
Borrowings are the easy part. The argument is over debt-like items: obligations that behave like debt but sit in current liabilities looking like ordinary working capital. This page sets out which items are commonly argued as debt-like, why, and how each one is evidenced.
What is the net debt formula?
The basic calculation is:
Net debt = bank and other borrowings + agreed debt-like items – qualifying cash
In a transaction, net debt sits between the headline price and the seller’s proceeds, alongside the working capital adjustment:
Equity value = enterprise value – agreed net debt + closing operating NWC – the NWC peg
Cash paid to the seller at closing can differ again because of escrow, deferred consideration, transaction costs and taxes. The bridge below excludes those items.
An illustrative example, in round units rather than dollars:
| Step | Amount |
|---|---|
| Headline price, cash-free and debt-free | 100 |
| Less bank loan and line of credit | (20) |
| Less debt-like items (accrued vacation, shareholder loan, unremitted sales tax) | (6) |
| Plus cash left in the business | 4 |
| Less working capital shortfall against the peg | (2) |
| Equity value before other deductions | 76 |
Some valuation models group the middle lines under a heading such as “other debt / (cash) items”. The label matters less than agreeing what goes on the list.
Which items are argued as debt-like, and how is each evidenced?
The organising principle is simple. Separate financing and specifically agreed debt-like obligations from ordinary operating balances. An amount is not debt-like merely because it arose before closing: trade payables, payroll accruals and other operating balances also arise before closing. First determine the obligation, then agree its treatment in the price bridge.
The table below is the list our transaction team works through. It describes what is commonly argued, not what any particular agreement must say: “debt-like items” is a negotiated definition, and the purchase agreement governs.
| Item | Why it is argued as debt-like | How it is evidenced |
|---|---|---|
| Bank loans, lines of credit, term debt, bank indebtedness | Financing, not trading. Repayment, assumption and release of security depend on the deal. | Loan agreements, bank statements, lender payout statements at close |
| Equipment, vehicle and finance lease obligations | Financing for assets the buyer keeps | Lease and financing agreements, amortization schedules reconciled to the balance sheet. Investigate an unexpected debit balance before deciding its treatment. |
| Shareholder, related-party and intercompany loans | Owed to the seller’s side and should leave with the seller, not arrive with the business | General ledger detail showing who the balance is owed to, any loan agreements, and why a related-party amount sits in receivables or payables rather than a loan account |
| Accrued vacation and payroll accruals | May be ordinary working capital, or specifically debt-like under the agreement; separate normal recurring accruals from exceptional obligations | Payroll registers and a vacation accrual schedule. Rebuild the schedule from payroll records if the accrual is unsupported. |
| Accrued bonuses for periods before close | Earned before close, paid after | Bonus plans, payroll history, board or owner approvals |
| Unremitted source deductions, GST/HST/PST and pre-close income tax | Determine whether the amount is a normal current remittance, overdue arrears, interest, penalties or seller-period income tax; treatment differs | CRA and provincial statements of account, filed returns, reconciliation to the balance sheet |
| Deferred revenue and customer deposits | The buyer may inherit performance and refund obligations. Treatment as working capital, debt-like or a separate price item is negotiated. | A deferred revenue schedule built from contract terms rather than invoice dates; deposits compared with costs already incurred against them |
| Pre-close amounts owed to landlords | Distinguish normal rent/CAM accruals from arrears, penalties or financing obligations | Lease, landlord common area maintenance (CAM) reconciliations, any landlord-funded leasehold improvements being recovered through rent |
| Non-operating balances on company credit cards | Personal or non-business spending is not an operating liability | Card statements and an estimate of normal monthly operating spend; the non-operating portion is separated out |
| Unrecorded liabilities found in diligence | Correct the omission, then classify the liability by its nature; unrecorded does not automatically mean debt-like | The diligence finding itself, supported by contracts, correspondence or payroll records |
Not on the list: supplier invoices, normal accrued operating expenses and receivables. Those are working capital and are settled through the net working capital peg.
Practitioner note: how do you avoid counting the same liability twice?
Use one account map across net debt, historical working capital and the closing statement. In a working capital walkthrough, our transaction lead described a seller’s calculation that included the current portion of loans in current liabilities. That was a financial-statement classification, but it did not match the cash-free, debt-free calculation being discussed. The financing balances had to be separated before comparing the peg and closing NWC.
Here is a hypothetical double-counting check. Suppose CAD 40,000 of overdue payroll deductions is agreed as debt-like and deducted from enterprise value. If it remains in closing NWC but was excluded from the peg, it also creates a CAD 40,000 working capital shortfall. The same amount has reduced equity value twice. Reconcile both schedules, including the historical treatment, before concluding the bridge is correct.
Deferred revenue needs the same discipline. Identify the remaining work, expected cost to fulfil it, any refund exposure and cash treatment. Then model the agreed treatment across the peg, closing NWC and net debt. A label such as “not quantified” is an open issue to resolve, not a zero balance.
The output should let both sides trace every disputed item to a document and see exactly where it enters the price. Our transaction advisory team prepares the financial schedules; the purchase agreement records the negotiated definitions.
How do leases fit into net debt?
Balance-sheet presentation does not settle purchase-price treatment. Under IFRS 16, lessees recognise a right-of-use asset and lease liability for most leases, subject to exemptions. ASPE distinguishes capital and operating leases, so an equivalent contractual commitment can be presented differently.
Agree the treatment of equipment financing and property leases explicitly. Also check the earnings measure used for valuation: lease accounting can affect EBITDA as well as debt. Deducting a lease liability without checking the corresponding earnings basis can make two otherwise similar valuations inconsistent.
What balance-sheet patterns deserve investigation?
Our transaction discussions include inventory balances that stayed unchanged for months, unsupported allowance accounts and credit-card payments that made trade payables look unusually small. Each pattern changes the document request:
- For static inventory, obtain counts, purchases, cost-of-sales entries and any obsolescence analysis. Do not delete a balance merely because it is static.
- For a round-number receivable allowance, obtain the aging, subsequent collections and basis of the estimate. Replace an unsupported estimate only with a supported adjustment.
- For low payables in a card-heavy business, reconcile supplier activity to card statements and the card liability. The obligation may have moved rather than disappeared.
- For related-party balances, identify the counterparty and whether the amount is a trading balance, financing or a distribution.
- For an unrecorded liability, establish the amount and period before deciding whether it belongs in NWC, debt or another adjustment.
These are investigation steps within quality of earnings work. They do not establish fraud or justify treating every unusual account as debt.
How does it come together at close?
- Identify debt: all borrowings, leases and financing, on or off the balance sheet.
- Identify debt-like items: work through the table above and document each one.
- Clean the balance sheet: reconcile unusual accounts and document supported corrections.
- Separate from working capital: nothing counted in both places.
- Deduct cash: on a cash-free, debt-free basis, with any trapped cash such as deposits held by others discussed separately.
- Settle at close: complete the agreed repayments, deductions and assumed obligations, against a schedule attached to the closing documents.
Discuss the categories in the letter of intent and settle the detailed definitions and schedules before closing. Our transaction advisory team builds this schedule as part of diligence; the legal drafting sits with your lawyer.
Frequently asked questions
What makes something debt-like rather than working capital?
Its nature and the agreed definition. Financing is distinct from normal trading, but payroll, bonuses and tax remittances need a closer classification. Identify whether the amount is recurring, overdue or exceptional, then reconcile its treatment across NWC and net debt.
Is deferred revenue debt or working capital?
It is negotiated. Deferred revenue is an obligation to deliver that the buyer inherits, so buyers argue it is debt-like; sellers argue it is ordinary working capital. Customer deposits sit in the same territory. Settle it explicitly with a schedule rather than assuming.
Do accrued vacation and unpaid payroll count?
They can be working capital or debt-like depending on the definition and whether they are normal recurring balances or exceptional obligations. Build a payroll-supported schedule and apply the same treatment to the peg and closing calculation.
What if the business has more cash than debt?
Then agreed net debt is negative. Qualifying cash left in the company can increase equity value; cash distributed before closing is no longer available for that addition. Required operating cash and restricted cash need separate definitions so neither is credited twice.
When should net debt be defined?
In the letter of intent, at least in principle. Leaving it to the purchase agreement means negotiating it when both sides have committed and one is inside an exclusivity period.
Where to next
If you are heading into a transaction, the debt-like list is where headline price and actual proceeds diverge, and it can be longer than a seller expects. Our transaction advisory services team quantifies it as part of diligence. Read the net working capital peg alongside this, since the two are settled together, and use the QoE readiness check to see how ready the books are. To talk through a specific deal, email Avnit Sekhon at avnit.sekhon@treewalk.com.
