Net debt vs. working capital in business sales: What every owner should understand

Enterprise Value, Net Debt, and Equity Value: The Framework
In most M&A transactions, the buyer and seller agree on what is known as an enterprise value—a value for the business on a debt-free, cash-free basis and assuming a normal level of working capital.

From this enterprise value, adjustments are made for:
- Net debt: the financial obligations of the company less any cash,
- Working capital: the operational liquidity of the business at the point of handover.

These adjustments result in the equity value, which is the amount ultimately paid to the shareholders.
 

What Is Net Debt?
Net debt is, in essence, the total financial liabilities of the company less its cash balances. This includes bank loans, overdrafts, and certain lease obligations, and may also include accrued interest, or even unpaid dividends, depending on the transaction structure.

Buyers generally expect to acquire a business that is free of financial debt. Any outstanding debt is therefore subtracted from the enterprise value.

Typical net debt items include:
- Bank loans and overdrafts
- Finance leases 
- Unpaid interest or loan fees
- Less: unrestricted cash and short-term deposits

Why it matters:
As a seller, every pound of net debt effectively reduces your proceeds. A business with significant debt will deliver less equity value than one that doesn’t.
 

What Is Working Capital?
Working capital refers to the short-term assets and liabilities needed to operate the business on a daily basis. In M&A, buyers expect to acquire a business with a normalised level of working capital, sufficient to keep trading in the ordinary course post-completion.

Working capital is calculated as:
Current Assets – Current Liabilities

But it’s not quite that simple. What’s considered “normal” is based on historical trends and negotiation. If, on completion, the business has more working capital than expected, the seller benefits. If there is less, the price is reduced accordingly.

Typical working capital items include:
- Trade receivables
- Inventory / stock
- Trade payables
- Accruals and prepayments

Why it matters:
Buyers don’t want to inject cash for working capital just after they’ve bought the business. Sellers, meanwhile, want to ensure they’re not leaving excess value behind.
 

Net Debt and Working Capital: Why the Distinction Matters
Some financial items could be considered either net debt or working capital, and how they are categorised can have a meaningful impact on the final proceeds received by shareholders. It is not uncommon for these classifications to become a focus of debate and negotiation.

To determine if an item is Net Debt, ask:
- Is it a financing obligation?
- Is it repayable outside of the normal trading cycle?

To determine if it is Working Capital, ask:
- Does it recur in the day-to-day operations of the business?
- Will it unwind naturally through trading?
 

Real-World Examples: Grey Areas in Practice
Customer Deposits:
- Nature: Payments received in advance of delivering goods or services.
- Treatment: Typically working capital.

Deferred Income (Unearned Revenue):
- Nature: Revenue received but not yet recognised.
- Treatment: Generally included in working capital. However, some buyers may argue for a net debt treatment if they are inheriting a substantial delivery obligation.

Accrued Expenses (e.g., Bonuses, Taxes):
- Nature: Costs incurred but unpaid at completion.
- Treatment: Often working capital unless clearly related to the transaction or non-operational.

IFRS 16 Lease Liabilities:
- Nature: Accounting liability for long-term leases.
- Treatment: Increasingly treated as net debt in larger or international transactions, but the treatment should be specifically agreed in advance.
Impact on Equity Proceeds

To illustrate how these adjustments affect proceeds:

Example:
- Enterprise Value: £10,000,000
- Net Debt: £(1,500,000)
- Working Capital Adjustment: +£250,000
- Equity Value to Seller: £8,750,000
 

What This Means for You as a Business Owner
While you don’t need to become an expert in accounting standards or SPA drafting, it is important to appreciate how these concepts influence the outcome of a transaction.

If you are preparing for the sale of your business, understanding how net debt and working capital operate within a completion mechanism is essential. These are not mere technicalities—they are powerful levers in the process in determining the cash you receive from the transaction.

At Heligan Group, we bring decades of transactional experience advising high-value business owners and entrepreneurs across sectors. Our role is to ensure that when you exit, you do so on terms that reflect the true worth of what you’ve built—clearly, confidently, and with no surprises.