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The Meaning of ‘Debt Free Cash Free’ - Updated

We last wrote about this topic in August 2012 and we have recently come across some new information which readers may find useful.

 “£XXX for 100% of the shares of XYZ Ltd on a debt free, cash free basis

This approach is commonly used in the sale of the shares of a limited company.  Shares rather than assets are usually sold because of the significant benefits which are available to the seller under Entrepreneur’s Relief tax legislation. However, the sale of shares introduces the principle of ‘debt free cash free’.

When a purchaser buys the shares of a business, at the point of completion, the acquirer ‘inherits’ the balance sheet and the debt free, cash free principle requires that the balance sheet at the point of sale is free of:

  • Debt - it is the vendor’s responsibility to clear all bank and other debt (eg due to/from directors) prior to completion. The usual exception to this is HP/Lease finance which generally transfers with the business.  In industries where it is standard practice to have invoice based finance (eg temporary recruitment agencies), this may also be transferred with the business.
  • Surplus Cash - it is the vendor’s right to either withdraw any surplus cash at Completion, or, better still (for tax reasons but see below), if purchasers can be persuaded to pay for the cash, to add this to the consideration due. The calculation of what constitutes surplus cash is a matter for the accountants to work out, but the principle is that a going-concern business should be left by the vendor with sufficient cash to not need to borrow over the working capital cycle.  So, for instance, if a large VAT payment is due a couple of weeks after completion the vendor would be expected to leave sufficient cash in the business to clear this.

The benefit of persuading acquirers to purchase Surplus Cash is that, in principle, this cash is then subject to Entrepreneur’s Relief meaning that the vendor will potentially pay ‘only’ 10% tax on it.  The new information we have been given is that HMRC can be expected to raise questions about this if the amount paid for Surplus Cash is greater than 20% of the Consideration.  Vendors should therefore speak with their tax advisers about this topic ahead of any sale.

If you are interested in selling your business now or in the future please contact Anderson Shaw. 

Anderson Shaw has offices on the outskirts of Stratford-Upon-Avon and provides business broker and corporate finance services for clients throughout the Midlands and the UK.

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