Finance Leases - debt-like or not debt-like

In general, the treatment of operating leases and finance leases in calculating Equity Value is non-contentious – but are they considered to be debt-like or not debt-like items?

What are the differences in the treatment of an operating lease and a finance lease?

  Operating lease Finance lease 
 Balance sheet Off balance sheet On balance sheet 
 P&L charge Rental charge deducted in arriving at EBITDA  Depreciation charge and interest charge, both charged below EBITDA 
 Included in debt calculation* No, as a deduction has already been taken for the operating lease through Enterprise Value Yes, as no deduction has been taken in arriving at Enterprise Value

 *Assumes the Bidder has calculated the Enterprise Value as a multiple of EBITDA.

Practical considerations:

Finance lease liability

A Seller may try to include the short-term portion of the Finance lease liability within working capital and not treat it as debt. Bidders should argue against this treatment based on the principles noted above. The Bidder should recalculate the working capital target excluding the finance lease liability and should include the finance lease liability within debt.                                      

Asset life and repayment terms

Consideration should be given to the relationship between the useful economic life of the leased asset and the repayment term of the associated debt. To the extent that the asset life does not significantly exceed the repayment term, a Bidder would need to ensure that they have factored any replacement cost (be it through a subsequent finance lease, operating lease or capex spend) into their valuation model.

Management accounts and stat accounts

Some companies treat leases differently between their management accounts and stat accounts. For example, to compare across business units, a company may treat all leases as operating leases in the management accounts. In such cases, a buyer may wish to consider whether there is a preferable treatment for the purposes of pricing i.e. is the deduction from Enterprise Value (rental cost * the multiple) preferable to deducting the finance lease liability as a debt-like item, or vice versa? This is a potentially tricky area and needs to be considered in conjunction with the EBITDA used for valuation and any Q of E items in respect of the lease treatment.


Find out more about this and other issues that arise during the sale & purchase agreement (SPA) at our forthcoming seminar on Thursday 6th October at 8:30am in London. Full details and registration can be found here.

What issues have arisen for you around leases on deals you’ve done? How did you get around them and what was the outcome? Share your thoughts below or schedule a meeting to discuss your situation in confidence.

Nick Williams | Sales & purchase agreement specialist
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