Enterprise value versus equity value: the gap that surprises founders

In most UK SME share sales, the figure agreed at heads of terms is an enterprise value. This is the value of the business itself, before any adjustments for the cash it holds, the debt it carries, and whether it has the right amount of working capital at the point of handover. It is a useful starting point for negotiation, but it is not the number that lands in the founder’s account.

The number that actually arrives is the equity value: enterprise value adjusted for cash, debt, and the working capital position at completion. In plain terms, the buyer is saying they will pay the agreed value for the business, on the assumption that it arrives with no financial debt, with a normal level of working capital to keep it running, and with surplus cash above that level extracted or credited to the seller. Every deviation from those assumptions adjusts the price.

For founders who have focused on the valuation conversation and left the mechanics for later, this is where the disappointment sets in. A strong EBITDA multiple and a well-negotiated enterprise value can still produce a lower-than-expected equity value if the adjustments run in the wrong direction. Understanding how those adjustments work, and negotiating them properly before heads of terms are signed, is one of the most commercially important things a founder can do in a sale process. Our exit planning advisory work with founders specifically covers this layer of deal mechanics, not just the valuation.

What cash-free, debt-free really means in practice

Most UK SME deals are structured on a cash-free, debt-free basis. This sounds straightforward: the buyer pays enterprise value, the seller takes any surplus cash out beforehand, and the buyer takes the business free of financial debt. In practice, the phrase covers a significant amount of detail that is rarely spelled out clearly at heads of terms stage.

Bank loans and overdrafts are the obvious debt items and rarely cause much argument. The harder questions sit around what else gets treated as debt for pricing purposes. Tax balances, director loans, finance lease and hire purchase obligations, deferred consideration owed on previous acquisitions, unpaid bonuses, and certain provisions may all end up within the debt definition if the SPA says so. The buyer’s starting position is typically to define debt as broadly as possible. The seller’s job is to push back on items that are either already captured in working capital or that represent normal trading liabilities rather than financial debt.

The cash side requires equal attention. Not all cash in the business at completion necessarily flows to the seller. Ring-fenced customer deposits, cash held against regulatory requirements, or restricted cash balances may be carved out. The definition of what counts as freely available cash needs to be agreed precisely, not left to be resolved when the completion accounts are being prepared and both sides have less room to negotiate.

Working capital adjustments: the most common source of post-signing pain

Working capital is the money tied up in day-to-day trading: trade debtors, stock, and trade creditors are the core components. A buyer acquiring a business needs it to arrive with enough working capital to keep operating without immediately injecting additional cash. That is a reasonable commercial position. The way it is implemented in the SPA is where founders regularly encounter unexpected reductions in their proceeds.

The mechanism works through a working capital target, sometimes called a peg. The parties agree a level of working capital that the business should have at completion, representing normal trading. If actual working capital at completion is above that target, the seller receives more. If it is below, the seller receives less, or in some structures is required to pay the difference back to the buyer after completion. The adjustment is typically pound for pound, with no floor or cap unless specifically negotiated.

A worked example makes the impact clear.

Nothing went wrong with the valuation in this example. The enterprise value held. The adjustments did the damage, reducing proceeds by £850,000 on an £8 million deal. That is not unusual in UK SME transactions where the mechanics were not addressed carefully at heads of terms stage.

How the working capital target is set and where disputes begin

The target is usually set by reference to historic trading, often a 12-month average of month-end working capital positions. For businesses with seasonal patterns, long project cycles, or material month-to-month variation, the choice of methodology and period matters considerably. A target based on a period that does not reflect normal trading for the business can set up a completion adjustment that neither party intended.

Problems compound when the methodology is left vague at heads of terms. Delayed customer receipts, one-off stock purchases, exceptional cost timing, or unusual supplier payment patterns can all distort the target. If the parties have not agreed precisely how to treat these items, they create room for argument once the deal is live and both sides have invested heavily in completion. A weak definition of normal working capital often becomes an expensive post-completion dispute.

Timing also matters in a way founders often underestimate. In many deals, the final working capital figure is not fixed on completion day. It is settled 60 to 90 days after completion, once the accounts have been prepared, reviewed, and agreed by both sets of advisers. For a founder who has personal tax bills, bank debt to repay, or investment plans tied to completion proceeds, that delay can create real cash flow pressure at an already demanding moment.

Debt-like items: the grey area that chips away at price

Debt-like items are liabilities that the SPA treats as equivalent to financial debt for pricing purposes, even when the management accounts do not classify or present them that way. This is the area of SPA drafting where legal wording and financial analysis most frequently collide, and where sellers who are not well-advised can lose significant value through imprecise definitions.

Buyers typically push for a broad debt-like items definition because every item included reduces the price they pay. A seller’s advisers should push back on anything that is already captured within the working capital target, anything that represents a normal trading liability rather than a financing obligation, and anything that is genuinely one-sided in its risk allocation.

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  Unpaid corporation tax, VAT, or PAYE exposures. Clear debt-like items where they represent actual liabilities at completion. The risk is where accrued but not yet assessed tax is treated as a deduction before any HMRC position is established.
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  Director loans and shareholder loans. These are straightforward debt-like items when they are genuine financing arrangements. They become contentious when the amounts are small and relate to normal business expenses rather than equity replacement financing.
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  Finance lease and hire purchase balances. Clear debt-like items under most structures, but the treatment of operating leases under IFRS 16 can create complexity in businesses that have adopted that standard in their management accounts.
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  Unpaid bonuses and commission accruals. Fair deductions where the bonuses relate to periods before completion and are genuinely owed. Contentious where the SPA definition captures accruals that are already included within the working capital target, effectively reducing price twice.
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  Customer deposits and advance payments. These may be normal trading items appropriately within working capital, or they may represent a genuine future delivery obligation that a buyer reasonably treats as a liability. The treatment depends on the business model and needs to be agreed explicitly.
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  Normal trade creditors within working capital. These should be excluded from the debt-like items definition and managed through the working capital mechanism only. Double-counting through both definitions is the most common and most costly SPA error for sellers.

The risk of overlap between working capital and debt-like items is the most significant structural issue in SPA pricing mechanics. If an item is treated as a debt-like deduction and also left within working capital as a creditor, it reduces price twice. Sellers should push for explicit schedules of included and excluded items, worked examples in the SPA where the definitions are complex, and clear carve-outs for items that are normal in the trading cycle of the specific business.

Completion accounts versus locked box: how the final number gets fixed

There are two main structures for fixing the final price in a UK SME share sale. Understanding the difference between them, and which is more appropriate for a given transaction, is important for a seller who wants to know when and how their proceeds will be confirmed.

Completion accounts remain the dominant structure in UK SME transactions because many smaller businesses have variable working capital, uneven cash flow patterns, and management accounts that are prepared to a lower standard than the precision the locked box mechanism requires. Buyers favour completion accounts because they provide protection against working capital deterioration between signing and completion.

For sellers, the completion accounts process has a specific procedural risk. The SPA will set out a timeline for preparing the accounts, reviewing them, raising objections, and resolving disputes. Review windows are typically 20 to 30 days. If a buyer raises objections and the parties cannot agree, an independent accountant may be appointed to determine the disputed items. Sellers need their own advisers lined up, their records in order, and a clear understanding of the accounting policies that apply, before that process begins rather than during it.

The SPA should also state the hierarchy of accounting policies: specific SPA definitions first, then the business’s historic accounting policies consistently applied, then UK GAAP where neither provides clear guidance. That hierarchy matters because disputes most commonly arise where the SPA definition is silent or ambiguous and the parties apply different historic conventions.

Holdbacks, escrows, and the timing of your cash

Even when the completion mechanics are well-structured and the adjustments are modest, founders frequently encounter cash flow issues in the weeks and months after completion that they did not anticipate. The most common cause is a holdback or escrow arrangement that defers part of the proceeds.

A holdback retains part of the price, either in a solicitor’s account or in escrow, until the completion accounts are agreed and the adjustment is settled. The amount held back is typically sized to cover the maximum likely downward adjustment, which can be a significant sum on a larger transaction. Even where the final adjustment is small, the full holdback amount is unavailable to the seller until the process is resolved.

Warranty and indemnity provisions can create a second layer of deferred cash. Where the buyer requires a retention against warranty claims, which is more common in deals without W&I insurance, that amount may be held for 12 to 24 months after completion. The combination of a working capital holdback and a warranty retention can leave a meaningful proportion of the headline proceeds out of reach during a period when the founder is dealing with personal tax bills and the opportunity cost of cash not yet received.

Founders should model the timing of their cash receipts alongside the headline proceeds when evaluating any deal structure. The total proceeds matter, but so does when they arrive. A deal that pays 85% on completion and 15% in escrow over 18 months is structurally different from one that pays 100% on completion, even if the headline numbers are identical. Planning for this timing gap, including the personal tax implications, is part of the preparation work that experienced M&A advisory support should cover well before heads of terms are agreed.

How to protect your proceeds before signing the SPA

Sellers have considerably more control over these mechanics than most realise, but only if they act early. By the time the SPA is in heavy markup and the buyer’s lawyers have set the drafting in their favour, the commercial leverage has shifted and some battles become very difficult to win. The time to address working capital targets, debt-like item definitions, and price mechanism structures is before heads of terms become binding, not after.

Define the terms and model the outcomes before heads of terms

The working capital methodology should be agreed in principle at heads of terms stage, not left for the SPA. That means agreeing the components to be included, the period to be used for the target calculation, how seasonality or one-off items will be treated, and whether any specific items will be excluded from either the working capital or debt-like items definitions.

Once the methodology is agreed, model the outcomes. Sellers should understand the best case, base case, and downside for their actual proceeds before they are committed to a structure. That means building a simple bridge from the agreed enterprise value to estimated equity proceeds under different working capital and debt scenarios, and understanding what the completion accounts process would look like in each case. For founders who need support with this financial modelling work, doing it before heads of terms are finalised costs a fraction of what it costs to address later.

Prepare the balance sheet before going to market

Clean balance sheet preparation reduces both the adjustment risk and the disputation risk. Reconcile tax positions and resolve any outstanding HMRC matters before the sale process begins. Review debtor ageing and chase material overdue amounts. Manage stock levels with care and ensure stock records are accurate. Review creditor positions and ensure supplier statement reconciliations are current.

At the same time, avoid balance sheet movements that look like window dressing. A buyer who sees unusual debtor collections, accelerated cash receipts, or deferred supplier payments in the months immediately before completion will assume those movements reverse after handover and may adjust the working capital target or the completion accounts accordingly. Normal trading, presented cleanly, is far more persuasive than an optimised snapshot. Our post on why business sales fall apart at due diligence covers the balance sheet preparation issues that most commonly create problems during a buyer’s review.

Push for precision in the SPA drafting

Vague definitions benefit the party with more time and resources to argue about them, which is almost always the buyer. Sellers should push for explicit schedules of items included and excluded from both working capital and the debt-like items definition. Where the business has specific features, such as advance payments from customers, seasonal stock builds, or project-specific billing patterns, those should be addressed explicitly in the drafting rather than left to a general definition.

Worked examples embedded in the SPA where definitions are complex are a practical tool that reduces post-completion disputes significantly. They demonstrate how the parties intended the mechanism to operate in practice, which is far more useful than abstract drafting language when a disputed item arises 90 days after completion.