business valuations – cash free, debt free; net asset basis; working capital adjustment

Question

In the context of M&A or business/company purchase and sale transaction, the purchase price seems to be based on one of either cash free, debt free basis with working capital adjustment or net asset basis of a company.
Why would a purchaser chose one over the other / what factors would be taken into account in deciding the basis of the business valuation

Isn’t net asset and working capital potentially the same thing?

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Answer 1

Price is a very funny thing. In school we are taught all these ways of calculating the price of a business, but the reality is that price is determined by what someone else is willing to pay and what the seller is willing to accept. All the formulas the thermos you get taught are all just ways of kind of estimating a price or creating a starting point for a negotiation.

The reasons a buyer or seller might choose one model of valuation over another is really more based on their own interests than anything.

Lets imagine a company that has a crapload of cash just sitting in it. They have business operations with say $100,000 in profit every year, but there’s $5,000,000 in cash just sitting in the company.

The buyer wants the operations and they value the operations at $2.5 million. So the question is, does the buyer need to pay 7.5 million for the operations and the cash, or can they buy only the operations and let the seller keep the cash. Seems obvious, why would anyone pay the seller cash in exchange for… cash. Using cash to buy cash is somewhat silly.

But the same can be said about debt. Why bother buying debt and then repaying it when you could just pay more and get the company with no debt. Sometimes there can be unforeseen problems in acquiring debt and it’s easier to just leave the debt back with the seller.

Net assets on the other hand would include both cash and debt. But all of this is kind of a pointless discussion since the end result of any such formula is really just a starting place for negotiations anyway. This is more of a textbook kind of question and not something that tends to happen in the real world.