Glossary
Net Debt and Debt-Like Items
Net debt is total borrowings less cash, and debt-like items are the obligations that behave like debt without being labelled as such. In a cash-free, debt-free transaction the seller clears them at close out of the proceeds, so they come directly off what the seller actually receives. At Treewalk we identify and quantify them, and the debt-like list is almost always longer than a seller expects.
The two lists
Obvious debt is straightforward: bank loans, lines of credit, term debt, vehicle and equipment financing, and lease liabilities on the balance sheet.
Debt-like items are the ones that cause arguments, because they sit in current liabilities and look like ordinary working capital:
- Shareholder and related-party loans
- Accrued vacation and unpaid payroll liabilities
- Accrued bonuses relating to periods before close
- Deferred revenue and customer deposits, where the obligation transfers to the buyer
- Unremitted source deductions or sales tax
- Off-balance-sheet obligations and unrecorded liabilities surfaced in diligence
The organising principle is simple. Anything that is a loan, or anything outside the normal course of operations, comes out. What remains is genuine operating working capital.
Why this decides real money
Net debt and the working capital peg are the two adjustments between headline price and what the seller banks, and they interact.
The most common error we correct is a seller’s accountant classifying the current portion of long-term debt inside current liabilities. That is technically correct presentation, but if you then compute working capital straight off the balance sheet, those liabilities reduce the working capital figure, which understates the peg and quietly shifts value. When we see it, we do not use the seller’s calculation. Every loan comes out of working capital and goes into net debt where it belongs, and the peg is rebuilt from what actually remains.
The related-party loans matter for a different reason. The exercise exists partly to confirm that anything owed to shareholders or related parties is repaid from the transaction proceeds rather than assumed by the buyer. Those balances should leave with the seller, not arrive with the business.
Small business balance sheets are usually wrong
Before you can calculate net debt you need a balance sheet that reflects reality, and on owner-managed targets that is not a given. Two patterns recur.
Accounts that never move are not real. An inventory balance that sits at the same figure for nine months, jumps, then freezes again has not been counted. Nobody is valuing it. We treat that number as unreliable and substitute an estimate built from what the business actually holds. Allowances for doubtful accounts behave the same way: a round figure that never changes was entered once and forgotten.
Payment method distorts payables. Where a business pays almost everything by company credit card, accounts payable will look implausibly small and static, because the real obligation sits on the card rather than in AP. Reading AP at face value there understates liabilities and flatters the cycle.
None of this is unusual and very little of it is deliberate. Small business balance sheets are messy, and correcting them is a normal part of the work rather than an accusation.
How it comes together at close
| Step | What happens |
|---|---|
| Identify debt | All borrowings, leases and financing, on or off balance sheet |
| Identify debt-like items | Shareholder loans, accruals, deposits, unremitted amounts |
| Deduct cash | Cash-free, debt-free basis |
| Clean the balance sheet | Remove accounts that are not real before anything is computed |
| Separate from working capital | Nothing counted in both places |
| Settle at close | Seller clears the debt and debt-like items from proceeds |
The row that gets fought over most is the fifth. An item cannot sit in both net debt and working capital, and whichever side it lands on, someone gains. Agreeing definitions in the letter of intent rather than at close removes most of that argument.
Frequently asked questions
What makes something debt-like rather than working capital?
Whether it arises from normal trading. A supplier invoice is working capital. A shareholder loan, an accrued bonus for a prior period, or unremitted payroll deductions are financing or historic obligations, so they are debt-like. The test is whether the buyer inherits an obligation created before close that is not part of running the business day to day.
Is deferred revenue debt or working capital?
It depends on the deal and it is genuinely 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 rather than assuming.
Do accrued vacation and unpaid payroll count?
Usually yes. They are amounts earned by employees before close that the buyer will eventually pay, so they typically sit as debt-like items settled by the seller.
What if the business has more cash than debt?
Then net debt is negative and, on a cash-free debt-free basis, the surplus cash leaves with the seller. What matters is not confusing surplus cash with the operating cash the business genuinely needs, which belongs in the working capital discussion.
When should net debt be defined?
In the letter of intent, at least in principle. Leaving the definition until the purchase agreement means negotiating it when both sides have already committed and one of them is locked inside a signed 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 is worth understanding before you agree a number. Our transaction advisory services team quantifies it on every engagement. Read the net working capital peg alongside this, since the two are settled together. To talk through a specific deal, email Avnit Sekhon at avnit.sekhon@treewalk.com.
