This post uses hypothetical scenarios for illustrative purposes only. It does not describe any actual client, transaction, or representation, and is not legal advice.
The 2026 founder cash-out story plays out the same way more often than anyone wants to admit. A founder sells his company. The headline enterprise value on his LOI is forty-two million dollars. He spends the prior six weeks telling his wife, his accountant, and the close friend who loaned him the seed money that the proceeds will be in the high thirties. The wire hits the day of closing. The wire is thirty-one and a half million.
Nothing illegal happens. Nothing surprising happens, from the buyer’s side. The deal closes on the terms the buyer’s lawyers had drafted, the terms the seller’s prior counsel signed off on at LOI, and the terms the accounting firm had modeled. The phrase “cash-free, debt-free” is on page one of every document. The founder reads it every time. He simply does not understand what it means. The phrase is the single most misunderstood term of art in private-company M&A, and the gap between what founders hear and what the contract does is large enough that most founders only learn it the way this hypothetical founder did — at the wire.
The phrase is a definition fight in disguise
“Cash-free, debt-free” sounds neutral. The founder hears it and pictures something clean. The deal is priced at enterprise value. At closing, the buyer pays off the company’s debt, the seller keeps the company’s cash, and the seller takes home enterprise value minus debt plus cash. Three line items, all sitting on the balance sheet, all easy to verify.
That is not what the contract does. What the contract does is define “Debt” and “Cash” — usually capitalized, usually defined in a schedule, usually drafted by the buyer’s lawyer, and usually accepted by the seller’s lawyer with light edits at best. The defined terms do not match the balance-sheet line items. They are negotiated allocations dressed up as accounting categories. The fight over what goes in each bucket is the deal, and the LOI is where most of it gets quietly lost.
The pattern is consistent across mid-market deals. The buyer wants a long, expansive “Debt” definition and a short, restrictive “Cash” definition. The seller, who has been told the deal is cash-free, debt-free, does not see the asymmetry until it is too late. By the time the founder is reading the closing flow of funds memo, the categories have been set, and the negotiation is over.
Three categories do most of the damage
First, the “debt-like items” expansion. The buyer’s definition of “Indebtedness” never stops at funded bank debt. It pulls in capital leases — fair enough, those are debt in any reasonable view. Then it pulls in deferred purchase price from earlier tuck-in acquisitions the target made. Then accrued bonuses earned but not yet paid, accrued PTO, severance liabilities, deferred revenue (controversially — more on that in a minute), customer prepayments, gift-card balances, pension underfunding, uncertain tax positions, environmental reserves, and transaction expenses the seller is paying. By the time the definition is fully assembled, “debt” is a six-page schedule of accruals and contingencies that bear no relation to anything a CFO would have called debt before the buyer’s lawyer drafted it.
The line that draws the most blood, in practice, is deferred revenue. A SaaS company with annual contracts collects cash upfront and recognizes revenue ratably over twelve months. The unrecognized portion sits on the balance sheet as deferred revenue, a current liability under GAAP. The buyer’s argument is that the company has the cash but still owes the service, so the cash is “encumbered” and should reduce the purchase price. The seller’s argument is that the company is being paid for that service in the ordinary course, and the cash is already in the “Cash” bucket, so subtracting deferred revenue is double-counting. Both arguments have force. The result depends entirely on who drafts the definition and how aggressive the LOI was at locking in the boundaries.
Second, the “cash — but not really” subtraction. The cash on the balance sheet is rarely fully creditable to the seller. Buyers carve out “trapped cash” in foreign subsidiaries where repatriation would trigger withholding tax. They carve out “minimum operating cash” the business needs to run for the first thirty or sixty days post-closing — a number the buyer’s CFO will pick, and which can easily run into seven figures even for a mid-eight-figure deal. They carve out restricted cash supporting letters of credit, cash subject to bank account control agreements with the company’s own lenders, and cash that on closer inspection is customer deposits that should never have been in “Cash” in the first place. By the time these subtractions are applied, the cash component is often half what the seller thought it was.
Third, the working-capital adjustment interaction. Most cash-free, debt-free deals also include a net-working-capital true-up against a peg. The peg is usually set at the trailing-twelve-months average, which sounds reasonable, but the components of NWC are negotiated separately from Debt and Cash. If accrued bonuses are pulled out of NWC (because they are sitting in Debt) but not removed from the peg, the seller pays the bonus twice — once because it is in Debt, and again because the company’s working capital is artificially lower than the peg by the amount of the accrued bonus. The asymmetry between the buyer’s drafting and the seller’s intuition on these mechanics is one of the things that makes private-equity buyers so much more efficient at extracting value than founders expect.
What to fight, and where to fight it
The first fight is the LOI. By the time the definitive agreement is being drafted, the LOI has either pinned down the definitions or left them to the buyer’s discretion. Founders treat the LOI as a non-binding handshake. Buyers’ lawyers treat it as a binding allocation of every category that will later be papered. The LOI should name, at a minimum, what is and is not in “Debt” — specifically, whether deferred revenue, customer deposits, accrued bonuses, capital leases, and prior earnouts are in or out. It should name what is and is not in “Cash” — specifically, whether trapped foreign cash, minimum operating cash, and restricted cash are creditable. If the LOI does not address these items, the founder is signing a blank check for the buyer to fill in later.
The second fight is the NWC peg. The peg should be calculated on the same basis as the closing-date NWC — and that means the buyer needs to provide its actual calculation methodology, not just an average, before the founder signs. If the peg includes accrued bonuses but the closing-date calculation excludes them (because they are in Debt), the founder will pay the bonuses twice. If the peg includes deferred revenue but the closing-date calculation excludes it, the founder loses a working-capital credit on every dollar of unrecognized revenue. The fix is to require that the components of the peg and the components of closing NWC be defined identically, with a written reconciliation provided to seller’s counsel before signing.
The third fight is the cash carve-outs. Minimum operating cash should be capped at a specific dollar amount, not a percentage of revenue. Trapped foreign cash should be defined narrowly — actual repatriation cost, not theoretical regulatory exposure. Restricted cash should be limited to genuinely encumbered amounts with documented restrictions, not buyer-asserted operational reserves. Each of these carve-outs is a discount on the price that the buyer is taking without paying for it.
What founders actually need at the LOI stage
Two documents help. The first is a draft sources-and-uses schedule that the seller’s accountant prepares, using the seller’s own balance sheet, walking from enterprise value to estimated net proceeds. This document is what the founder should be carrying into LOI negotiation, with the numbers spelled out: here is the EV, here is what comes out for debt, here is what we expect to keep in cash, here is the working-capital target. When the buyer’s draft LOI uses different definitions, the seller’s accountant can put numbers on each delta. It is the difference between fighting in the abstract and fighting over a specific dollar amount that everyone can see.
The second is a definition addendum to the LOI that lists what is and is not in “Debt” and “Cash.” The buyer will resist this, on the theory that the LOI is meant to be a short, non-binding document. The founder should resist back. A two-page LOI that leaves the definitions for the definitive agreement is a two-page LOI that the founder will lose. A four-page LOI that fixes the major definitions is one the founder can actually plan around. The template form that founders sometimes work from is a useful sanity check on what a balanced agreement looks like, but the real protection sits one step earlier — in the LOI.
The mechanics of closing-accounts pricing are well-summarized in Winston & Strawn’s comparison of the locked-box mechanism and closing-accounts pricing, which is the cleanest short read on why the post-closing-adjustment world is so much more dangerous for sellers than the locked-box approach used in much of European private-equity practice.
The headline number is not the deal. The deal is the seven definitions underneath it, and most of them get written before the founder has a chance to push back. The fix is not to read the definitive agreement harder. The fix is to negotiate them at the LOI, before the leverage has shifted.
If you are a founder reading an LOI and trying to figure out what the wire will actually look like, feel free to reach out to my firm manager, Magda, at Magda@montague.law, or fill out our contact form. Mention you read this post.
— John
