Case 081Deal structuring and pricingCore
Enterprise value is agreed at Rs 1,000 crore. With unfunded gratuity, customer advances, capex creditors and trapped cash on the balance sheet, what equity price follows?
1The situation
You are negotiating the purchase of Harikul Engineering, a maker of industrial pumps. Both sides have agreed an enterprise value of Rs 1,000 crore. The seller's banker proposes an equity price of Rs 810 crore: enterprise value less Rs 250 crore of bank debt plus Rs 60 crore of cash.
Diligence has found four things. The gratuity liability to employees is Rs 30 crore and no fund has been set aside for it. Customers have paid Rs 40 crore in advance for pumps not yet built. Rs 25 crore is owed to the contractor who built the new plant, due in two months. And Rs 20 crore of the cash sits in an overseas subsidiary where repatriation would cost tax and take a year.
2Your task
Build the bridge from enterprise value to equity, say which items you would fight for and which you would concede, and name the equity price you would offer.
Quick check
Which of the four findings is the seller most likely to argue should not reduce the price?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Offer about Rs 695 crore of equity, Rs 115 crore below the seller's Rs 810 crore. From Rs 1,000 crore of enterprise value, deduct bank debt of 250, the unfunded gratuity of 30, customer advances of 40 and capex creditors of 25, and add back only the Rs 40 crore of cash you can actually use. Gratuity and capex creditors are not negotiable; advances are the item to trade, and if conceded the price is Rs 735 crore.
Step 1Why does the headline not settle the price?
Because enterprise value is the value of the business before anyone asks who is owed what. Buying a flat for Rs 1 crore and then finding unpaid society dues, a pending contractor bill and a deposit the seller took from a tenant does not change the flat's value; it changes what you hand the seller. Equity value is enterprise value less every claim that ranks ahead of the shares, and the bank loan is only the obvious one. The others hide in provisions, current liabilities and the cash line itself, and that is where a diligence team earns its fee.
Step 2Which items are debt-like, and why?
The test is whether the buyer will have to pay cash that the enterprise value already assumed was paid. The gratuity is Rs 30 crore of pay already earned by staff that the buyer will fund; the capex creditor is Rs 25 crore of a plant the EBITDA already benefits from; both are debt-like itemsObligations that are not borrowings but that the buyer will have to settle in cash, so they reduce equity value in the same way as debt. and come off the price. Customer advances are harder. The seller says every pump maker holds advances, so they are part of normal working capital. The buyer says Rs 40 crore of cash has been collected and spent, and the buyer will bear the cost of building those pumps. The usual settlement is to deduct the advances that are above the normal level, or to treat them as debt-like and let the seller argue for a higher working capital target.
| Rs crore | Seller's bridge | Buyer's bridge | Why |
|---|---|---|---|
| Enterprise value | 1,000 | 1,000 | agreed |
| Bank debt | (250) | (250) | borrowing |
| Unfunded gratuity | (30) | pay already earned, no fund | |
| Customer advances | (40) | cash received, work still to do | |
| Capex creditors | (25) | plant already in EBITDA, bill unpaid | |
| Cash | +60 | +40 | 20 is trapped overseas |
| Equity price | 810 | 695 | gap of 115 |
Step 3What about the trapped cash?
Cash counts only if it can be used to pay down the debt you are replacing. The Rs 20 crore overseas is real but costs tax and a year to bring home, so a buyer counts it at a discount or not at all, and here it is excluded. A middle ground is to count it net of the repatriation tax, or to let the seller bring it home before closing and take the credit then. Minimum operating cash, the float the business needs in tills and accounts, is the same idea: it is on the balance sheet, but it is not free.
Step 4What do you say in the room?
Lead with the items you will not move on and trade the one you will. Gratuity and the capex bill are facts, Rs 55 crore off, and trapped cash is a timing problem the seller can fix before closing if they want credit for it. Advances are the negotiating item: offer Rs 695 crore, know that conceding them takes you to Rs 735 crore, and decide in advance where you stop. The number on the term sheet is the bridge, not the headline, and the bridge is usually where a deal's return is won or lost after the multiple has been agreed.
Where candidates lose it
The usual loss is treating the bridge as enterprise value less debt plus cash and stopping, which is exactly the seller's version. The question lists four findings because each one is a different kind of claim, and the interviewer wants each classified.
The second is deducting everything with equal confidence. Customer advances are genuinely arguable, and a candidate who cannot say why the seller will resist that item has not understood working capital.
What the interviewer asks next
- The seller offers to fund the gratuity trust before closing. Does the price go back up by Rs 30 crore?
- How would a working capital adjustment mechanism in the sale agreement handle the advances instead?
- There is also an operating lease on the head office. Is that debt-like?
Company names and figures are illustrative.