Quick answer: Debt-like items are obligations that a buyer treats as debt even though they are not loans, so the amount is deducted from the price dollar for dollar. Common examples are accrued bonuses and vacation, deferred revenue and customer deposits, unpaid taxes, deferred rent, finance leases, unfunded retirement promises, unpaid transaction expenses and loans from owners. Each is negotiated in the letter of intent and the purchase agreement, and the definitions matter as much as the price.
Key points
- The test for a debt-like item is whether paying it after closing means the buyer funds something the seller’s ownership period created. Items that pass come off the price dollar for dollar.
- The same obligation can sit in working capital or in debt, and the choice changes who bears it. An item must be counted once, so the working capital target and the debt definition are settled together.
- A deduction for a debt-like item is not multiplied by the valuation multiple, but an earnings adjustment is. Where an item lands matters as much as how large it is.
- Settle definitions in the letter of intent. A schedule of agreed categories, each with a measurement method, removes most late disputes over proceeds.
The test a buyer applies to a candidate item
A debt-like item is an obligation of the business that a buyer treats as if it were a loan. The amount is deducted from the price dollar for dollar, and the seller bears it. Unlike an earnings adjustment, the deduction is not multiplied by the valuation multiple, which is why the argument about where an item belongs is worth as much as the argument about its size. The bridge from enterprise value to equity value shows where the deduction sits in the calculation of proceeds.
Buyers screen each candidate with three questions.
- Is it owed at closing for something the business has already received or earned?
- Does it come from the seller’s period of ownership, instead of recurring as part of ordinary operations?
- Is it outside the working capital target, so that it is not already measured there?
An item that passes all three is a strong candidate for a deduction. Sellers aim their arguments at the second and third questions, and at a rule both sides should accept: every dollar is counted once, in earnings, in working capital or in debt, and never in two places.
Item by item, with the argument on each side
The table lists the items that come up most often. The columns show how each side commonly frames the point, which is not a rule of any particular deal.
| Item | Why a buyer deducts it | Usual seller argument | Common settlement |
|---|---|---|---|
| Accrued bonuses, commissions and vacation | Earned by employees before closing and paid by the buyer afterward | A recurring accrual that the working capital target already reflects | Deducted in full with the target adjusted, or kept in working capital with a seasonal target |
| Deferred revenue and customer deposits | The seller holds cash for work the buyer must perform without being paid again | A normal operating cycle, and the buyer earns the margin on that work | Often settled at the cost to fulfill instead of the face amount, or kept in working capital with a target that reflects it |
| Unpaid taxes for earlier periods | The buyer inherits the entity’s history, or the liability belongs to the seller’s period of ownership | Paid in the ordinary course and covered by the seller’s own filings | Deducted, or covered by an indemnity or escrow, depending on the structure |
| Finance leases and equipment loans | They work as borrowing | Rarely contested | Treated as debt |
| Operating lease liabilities and deferred rent | A balance sheet obligation for the use of space or equipment | Rent is already an expense in EBITDA, so counting the liability as debt counts it twice | Usually excluded from debt while rent stays in EBITDA, with any rent accrued but unpaid treated as a payable |
| Unfunded deferred compensation, retirement and severance promises | Promises earned by past service and payable later | The amount rests on assumptions, and only the earned portion counts | Deducted at an amount calculated by a benefits specialist |
| Unpaid transaction expenses and sale bonuses | The sale caused them, and the seller engaged the advisors | Some are the buyer’s choice, such as its own financing costs | Paid out of closing proceeds, with the payee list agreed in advance |
| Loans from owners and related parties | Owed to the owner and repaid at closing | The repayment returns to the owner, and balances the owner owes the company offset it | Settled or netted in the funds flow at closing |
| Agreed but unpaid settlements and customer credits | A cost of past events with a fixed amount | Contingent claims belong in the indemnity and not in the price | Fixed amounts deducted, and contingent claims moved to a specific indemnity or escrow |
Liabilities generally follow the form of the deal. In an asset sale the buyer generally takes only the liabilities it agrees to assume, while in a stock sale the entity’s history comes with it, including obligations nobody has listed. The comparison of asset and stock sales explains the difference, and the seller’s CPA and attorney confirm which items stay with the seller under the structure chosen.
How the argument runs in the price bridge
An obligation can land in one of three places. In earnings, a recurring cost reduces EBITDA and is multiplied by the multiple. In working capital, a normal operating liability is measured against a target built from an average, which gives the seller credit for the normal level, as the net working capital peg guide explains. In debt-like items, an obligation for the seller’s period of ownership is deducted in full. Buyers tend to push items toward the place where the deduction is largest, and sellers toward the place where the normal level is credited.
A seasonal balance shows how much placement matters.
Illustrative example: The same bonus accrual treated two ways, and counted twice
A company pays an annual bonus pool of $300,000 each March for the prior calendar year. A sale closes on December 31, when the full $300,000 has been earned and is unpaid. The working capital target is built from monthly averages, and the accrued bonus liability averages $150,000 across the year, so the target already assumes a liability of that size.
| Treatment | How the price moves | Effect on the seller |
|---|---|---|
| Left in working capital | Delivered working capital carries a $300,000 liability against $150,000 in the target, a $150,000 shortfall | ($150,000) |
| Debt-like, and removed from the target | $300,000 is deducted as debt, and the target is rebuilt without the bonus accrual | ($300,000) |
| Debt-like, and left in the target | $300,000 is deducted as debt, and the same liability also creates a $150,000 working capital shortfall | ($450,000) |
The first two treatments are positions each side can defend. The third counts $150,000 twice. The numbers are invented to show the mechanics and are not benchmarks.
The double count usually comes from two schedules drafted by different advisors, not from intent. The working capital target and the debt-like definition should be written together, using the same accounting policies, with a clause that no amount is counted in both.
Negotiating the definitions
- Agree the categories in the letter of intent. A list of what is included and excluded keeps the purchase agreement from opening new ones. The letter of intent guide shows where these terms sit.
- Fix a measurement method for each category. Historical accounting policies for accruals, the cost to fulfill for deferred revenue, a benefits specialist’s calculation for unfunded promises, and a stated method for amounts due in later years.
- Settle the timing. Amounts are estimated at closing and trued up afterward, and disputes go to an independent accountant under the process in the agreement.
- Compare offers on definitions. An offer that looks higher may define debt more broadly, which the guide to comparing first-round offers explains in detail.
Finding the items before the buyer does
A seller can build the schedule first, because the buyer’s accountants build theirs from the same sources.
- Payments after year-end. Bonuses, vendor settlements and tax payments made in the weeks after a period end often belong to the period before it.
- Customer and vendor contracts. Prepayments, rebates and credits owed, sale or change-of-control bonuses, and amounts still owed to earlier sellers of the business.
- Payroll and benefit records. Accrued vacation, commissions, deferred compensation and severance promises, covered in the guide to HR and employment diligence.
- Leases and loan documents. Finance leases, guarantees and letters of credit.
- Tax notices and filings. Open periods and unresolved notices, discussed in tax diligence in a sale.
- Legal files. Settlements agreed but not yet paid, covered by legal diligence.
The resulting schedule belongs in the sell-side quality of earnings report and in the answers to the buyer’s accountants. The items that surface late, and the price effect of each, are listed in quality of earnings findings that reduce price, and the whole review is mapped in the guide to due diligence in a business sale.
Frequently asked questions
What is the difference between a debt-like item and working capital?
Working capital items are part of the normal operating cycle and are measured against the target, so the price moves only when delivered working capital differs from it. Debt-like items are obligations the buyer treats as borrowing, and they are deducted in full. An item should sit in one place only, so the parties define both together.
Is deferred revenue treated as debt in a business sale?
Sometimes. A buyer argues that the seller has been paid for work the buyer must now perform at its own cost. A seller argues that prepayments are a normal part of the operating cycle. Outcomes include a deduction at the cost to fulfill, a deduction of the full balance, or inclusion in working capital with a target that reflects it.
Do transaction expenses reduce what the seller receives?
Yes. Advisory, legal and accounting fees for the sale, and bonuses triggered by the sale, are generally paid out of the closing proceeds or deducted from the price. The seller should ask for the list of payees and amounts before closing so that the funds flow shows no surprises.
How are unpaid taxes treated in the price?
It depends on the structure. In a stock sale the entity’s history, including unpaid taxes for earlier periods, comes with it, so buyers commonly deduct them or require an indemnity. In an asset sale the buyer generally takes only the liabilities it agrees to assume. The seller’s CPA should confirm the treatment for the structure.
Do loans from the owner reduce the price?
They come off the price as debt, but the repayment goes to the owner, so the net effect on the owner is small. Balances owed by the owner to the company run the other way and are settled or netted at closing. The funds flow statement should show each balance and who receives it.
Preparing a company for sale or a buyer's diligence?
The Impetus Group offers fractional investment banking support, including earnings normalization, financial projections, CIM preparation and help navigating buyer diligence, with an engagement scoped to what the business needs.
Related guides
- From Enterprise Value to Equity Value: What the Owner Receives: Enterprise value is the price of the business. Equity value is what owners receive after debt, debt-like items, cash and working capital. See the bridge.
- Net Working Capital Peg: How the Working Capital Adjustment Works: The working capital peg sets the level of working capital a seller must leave in the business at closing. See how it is calculated, negotiated and adjusted.
- Indications of Interest: How to Compare First-Round Offers: An indication of interest is a non-binding first-round offer. See what it contains, how ranges hide differences and how to score bidders on net proceeds.
- Quality of Earnings Findings That Reduce Price and How to Pre-Empt Them: The quality of earnings findings that most often lower a sale price, such as rejected add-backs and cut-off errors, with how each appears and how to pre-empt it.
- How to Read a Letter of Intent: The Terms That Decide What You Receive: A plain-language guide to the letter of intent in a business sale: price, structure, working capital, exclusivity, diligence and the terms that move your proceeds.
- Sell-Side Quality of Earnings Report: Scope, Timing and How to Use It: What a sell-side quality of earnings report covers, when an owner should commission it, who should perform it and how to use it in the CIM and with buyers.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.