The enterprise value has been negotiated. The buyer and the seller have agreed on Rs 120 crore. The term sheet is signed. The lawyers begin drafting the share purchase agreement. The seller’s promoter calculates the proceeds and begins planning for life after the exit.
The promoter may be calculating too early. An agreed enterprise value of Rs 120 crore does not mean the seller receives Rs 120 crore. It means the business has been valued at Rs 120 crore before adjustments. The adjustments, net debt, working capital normalisation, quality-of-assets corrections, contingent liabilities and completion-account mechanics, determine what the seller actually receives. In practice, the gap between the headline enterprise value and the final equity cheque can be Rs 5 crore, Rs 15 crore or, in cases where the financial due diligence uncovers material issues, large enough to collapse the transaction entirely.
This article explains how an apparently agreed deal changes when the financial due diligence examines what sits beneath the headline number.
Enterprise value is not equity value
Enterprise value measures what the business is worth to all capital providers (equity holders and debt holders combined). Equity value measures what is left for the shareholders after debt and debt-like items are subtracted and free cash is added.
The formula is straightforward: Equity Value = Enterprise Value minus Net Debt plus/minus Working Capital Adjustment.
Each component contains judgment, and each judgment changes the cheque.
Net debt: what counts as debt
Net debt is not simply the outstanding bank loan. Net debt includes every obligation that behaves like debt: amounts the business owes that the buyer will inherit if they are not settled before completion.
In a typical Indian mid-market transaction, the items that expand net debt beyond the obvious bank borrowings include:
Overdue statutory dues. GST payable, TDS payable, PF and ESI contributions, professional tax, property tax. If these are overdue at completion, the buyer inherits the obligation and the associated interest and penalties. A company with Rs 45 lakh of overdue statutory dues has Rs 45 lakh of debt-like items that reduce the seller’s proceeds.
Unpaid capital expenditure. The company ordered Rs 80 lakh of machinery six months ago. The machinery has been installed. The vendor has not been paid. The payable is sitting in trade creditors but it is not a trading payable (it will not recur in the ordinary course of business). It is a capital commitment that the buyer will need to settle. It is debt-like.
Customer advances. The company received Rs 1.2 crore of advances from customers for goods not yet delivered. The advances are a liability (the company owes delivery or a refund). If the buyer inherits the obligation to deliver against those advances without receiving the corresponding revenue (because the revenue will be recognised only on delivery, which happens post-completion), the advance is debt-like.
Shareholder and related-party balances. The promoter has drawn Rs 35 lakh from the company as an unsecured loan. The company has paid Rs 20 lakh of the promoter’s personal expenses. The company has advanced Rs 50 lakh to the promoter’s other business. These are amounts the company is owed by insiders or has spent on non-business purposes. They are recovered from the seller at completion or deducted from the proceeds.
Contingent liabilities that are probable. A tax demand of Rs 60 lakh is under appeal. The company’s tax adviser assesses the probability of the demand being sustained at 70%. The buyer’s due diligence adviser assesses it at 85%. The treatment in the completion accounts (full provision, partial provision, indemnity, escrow) becomes a negotiation. The seller wants it excluded. The buyer wants it included. The resolution changes the proceeds.
Working capital: the normalisation exercise
The share purchase agreement typically specifies that the company will be delivered with a “normal” level of working capital. If the actual working capital at completion exceeds the normal level, the seller receives an upward adjustment. If it falls below, the seller receives a downward adjustment.
The definition of “normal” is where the negotiation begins.
The buyer’s adviser analyses the company’s working capital over the last 12 to 24 months, identifying the average level and the seasonal pattern. The analysis examines each component:
Receivables. The company reports Rs 8 crore of receivables. The ageing analysis shows Rs 1.5 crore older than 180 days, of which Rs 60 lakh is in dispute and Rs 40 lakh is owed by a customer that has filed for insolvency. The buyer’s adviser proposes that the disputed and irrecoverable receivables be excluded from the working capital calculation or provisioned in full. The seller argues that the disputed amount is valid and will be collected. The resolution determines whether the working capital is Rs 8 crore (seller’s position) or Rs 6 crore (buyer’s position), a Rs 2 crore difference in the equity cheque.
Inventory. The company reports Rs 5 crore of inventory. The physical verification reveals Rs 40 lakh of obsolete raw materials (superseded by a product redesign), Rs 25 lakh of finished goods that have been in stock for more than 12 months (slow-moving in an industry where the average sales cycle is 60 days) and Rs 15 lakh of packaging materials for a product that was discontinued. The buyer’s adviser proposes that Rs 80 lakh of inventory be written down to net realisable value. The working capital adjusts downward. The seller’s proceeds reduce.
Payables. The company has stretched its supplier payments to 90 days (against terms of 45 days) in the two months before the transaction, artificially inflating the working capital at the measurement date. The buyer’s adviser identifies the stretch by comparing the current payable days to the trailing 12-month average and proposes normalising the payables to the historical level. The normalisation reduces the working capital. The seller’s proceeds reduce.
A hypothetical transaction
Enterprise value agreed: Rs 120 crore.
The buyer’s financial due diligence identifies:
Net debt adjustments: bank borrowings Rs 18 crore, overdue statutory dues Rs 45 lakh, unpaid capex Rs 80 lakh, customer advances Rs 1.2 crore, promoter balances Rs 1.05 crore, contingent tax liability (provisioned at 85%) Rs 51 lakh. Total net debt: Rs 22.01 crore.
Working capital adjustments: irrecoverable receivables Rs 2 crore, obsolete inventory Rs 80 lakh, normalised payable stretch Rs 60 lakh. Net working capital shortfall against the target: Rs 3.4 crore.
Equity value: Rs 120 crore minus Rs 22.01 crore minus Rs 3.4 crore = Rs 94.59 crore.
The seller expected Rs 120 crore. The adjusted equity value is Rs 94.59 crore. The Rs 25.41 crore difference is not a negotiating tactic. It is the financial reality behind the headline number.
The seller’s options: accept the adjusted value, challenge specific adjustments with supporting evidence, negotiate indemnities or escrow arrangements for contingent items, or walk away from the transaction if the adjusted economics no longer meet the seller’s expectations.
The buyer’s options: proceed at the adjusted value, negotiate further adjustments for items the due diligence could not fully resolve, insist on contractual protections (warranties, indemnities, escrow, retention) for identified risks, or withdraw if the financial condition of the business is materially different from the initial assessment.
The purchase agreement: where findings become protections
The financial due diligence findings do not exist in isolation. They translate into specific clauses in the share purchase agreement:
The cash-free/debt-free mechanism ensures that all debt and debt-like items are either settled by the seller before completion or deducted from the purchase price. The definition of “debt-like items” is negotiated, and the due diligence determines what should be included.
The working capital adjustment mechanism ensures that the company is delivered with a normal level of working capital. The target is derived from the due diligence analysis. The completion accounts are prepared post-completion and compared to the target. The difference is settled between the parties.
Warranties and indemnities protect the buyer against risks identified during the due diligence that cannot be fully resolved before completion (tax disputes, litigation, regulatory proceedings, contractual claims). The seller warrants that the disclosed position is accurate and indemnifies the buyer if it proves otherwise.
Escrow and retention mechanisms hold a portion of the purchase price (typically 10% to 20%) for a defined period (12 to 24 months) to cover potential warranty claims and completion-account adjustments.
Each mechanism is a direct translation of a due diligence finding into a contractual protection. Without the finding, the protection does not exist. Without the protection, the buyer carries the risk.
Northrop Management conducts financial due diligence for acquirers, private equity funds, family offices and corporate development teams. The engagement covers enterprise-to-equity bridge analysis, net debt identification, working capital normalisation, quality-of-assets assessment and completion-account advisory.
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