Your client wants to acquire “Flaming Delicious!”, a fast-food restaurant chain (main focus on burgers) in the Netherlands with 20 restaurants in the Netherlands and a further four restaurants abroad.

You are an analyst in the KPMG transaction services team and a number of team members have already had various conversations with the management team and read all the monthly management accounts, including commentary. They noted a number of items which they think could be debt / cash-like in nature and could therefore be included in the definition of debt in the SPA.


In your teams, discuss the following items and note those that you think would be an adjustment to net debt. Use these to calculate an adjusted net debt at 30 November 2016 (= FY16 year-end). Be prepared to justify the inclusion / exclusion of each item. Reported net debt (per the balance sheet) was €1,775,000.


Potential adjustments to Net Debt

  1. At November 2016 there was an accrual for employee bonuses of €80,000. These were paid in December 2016.
    Adjustment. We’ve already discussed bonuses. A seller might argue that the bonuses were required to motivate employees to generate EBITDA and are therefore the same as any other cost / creditor, but a purchaser would argue that the employees should have been doing their job to the best of their ability anyway and therefore bonuses were discretionary – the seller should pay.
  2. Net intercompany loans owed to Unifood and its subsidiaries were €650,000.
    Adjustment. These will need to be settled upon completion of the transaction and are essentially the same as any other bank / third-party loan.
  3. Accrued interest on the bank loan was €45,000.
    Adjustment. We’ve seen this before in the course. It is part of the amount we owe to the bank and is therefore debt.
  4. Prepaid rent at November 2014 was €70,000.
    No adjustment. This is working capital in nature – it is ongoing just like other debtors / creditors.
  5. Flaming Delicious! rents two closed sites to third parties. It has received €100,000 in deposits from the third parties, which are repayable on termination of the lease contract.
    Adjustment. This is a cash deposit that does not relate to a service – if the lease stopped tomorrow the cash would be repaid. Note that this is different to deposits received towards goods. i.e. a business such as camper vans where a customer puts down a deposit against an item that they will later receive.
  6. At any time there is approximately €10,000 in tills in the restaurants, providing a “float”.
    Debatable. This is often adjusted in deals as the cash is trapped. Does anyone know what that means and why it might lead to an adjustment? There will always need to be a float of approximately €10,000 in the tills going forward. Recall that the purchaser is paying the enterprise value to the seller and has therefore paid for this cash, which is included in the cash balance recognised. The purchaser then has to fund the float in addition to this.
  7. Flaming Delicious! has made an insurance claim after some kitchen equipment was stolen from one of the restaurants during refurbishment. It was replaced immediately at a cost of €45,000, which the insurance company has confirmed in writing that it will pay. The payment is likely to be made to Flaming Delicious! post completion.
    Adjustment. Flaming Delicious! has paid the cost of the refurbishment, but the cash will be received by the purchaser. The purchaser should pay this amount to the seller.
  8. Senior management at the Head Office of Flaming Delicious! are eligible for interest-free loans from the business. Currently a total of €30,000 is owed by three individuals, two of whom are directors.
    Adjustment. The amounts owed are repayable in cash and assuming they are not repaid prior to completion, the purchaser will get the benefit of the cash and should pay for it.
  9. Flaming Delicious! has guaranteed €1 million of loans owed by a different, small subsidiary of Unifood, for five years. The subsidiary has never defaulted on any loan payments and therefore Flaming Delicious! has never incurred any costs.
    Negotiate for change as part of the sale and purchase agreement and refer to legal DD. It is unlikely that this would remain in place following the transaction.
  10. Two restaurants are currently under construction. Flaming Delicious! owes building contractors €35,000.
    No adjustment. This is very often debated on transactions and there are always lots of arguments for and against. A seller would argue that it is a normal creditor, like any other. Can anyone think of a situation / reason why it might be adjusted? If we are valuing Flaming Delicious! using historical EBITDA, as we are now, it is likely that this is considered the case by all parties. However, if the seller is asking bidders to use a projected EBITDA, (or run rate EBITDA) then a purchaser could argue that without an adjustment they are “double paying” for the capex. They are paying for EBITDA (at a multiple) that the new restaurants will generate, but they are also paying for the new restaurants, over which they have no control (location, format, etc.). On a recent transaction I worked on the adjustment for capex creditors was well over €1 million.
  11. Accrued electricity costs at November 2016 were €15,000.
    No adjustment. These are working capital in nature.
  12. Corporation tax payable at November 2016 was €45,000.
    Adjustment. The corporation tax payable relates to profit from which Flaming Delicious! benefited. It should therefore pay the tax on it. The tax is dependent on the structure and profit of the Unifood Group and may change under new ownership. Note: it has been the case that this has been included as a working capital item, but is generally always considered net debt.
  13. An employee has sued Flaming Delicious! for damages after burning himself on the burger grill in a restaurant. The business is contesting that the employee was careless and did not follow health and safety guidance. Management has stated that they have no idea whether they will win or lose the court case and if they lose, how much of the €100,000 he has claimed will actually be awarded.
    No adjustment. If acting for a purchaser we would want to include an indemnity in the SPA, such that the seller would have to pay any compensation that results from this. As we are writing the VDD for Flaming Delicious!, it is likely that we would exclude it from our net debt analysis, but include it in a section of outstanding legal claims, off balance sheet liabilities, contingent liabilities, etc. and flag it in the executive summary as an issue. This would allow purchasers to make their own decisions.
  14. Accrued supplier rebates at November 2016 were €110,000, of which €65,000 was guaranteed based on amounts already purchased.Debatable. The seller would want to keep the benefit of these rebates and would want to adjust net debt by at least €65,000. The purchaser could argue that it is just like any other debtor!
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