How to Present Deferred Revenue During an M&A Process
In the sale of a software or technology company—particularly those with subscription-based or recurring revenue models—few balance sheet items generate as much scrutiny as deferred revenue. Handled correctly, it signals strong customer prepayments and future revenue recognition. Mishandled, it can trigger valuation disputes, working capital adjustments, or even derail a deal.
This article explores how to present deferred revenue during an M&A process, why it matters to buyers, and how firms like iMerge help sellers navigate its complexities to preserve value and avoid surprises.
What Is Deferred Revenue and Why It Matters in M&A
Deferred revenue—also known as unearned revenue—is a liability that arises when a company receives payment for goods or services it has not yet delivered. In SaaS and software businesses, this typically reflects prepaid annual or multi-year contracts.
From a buyer’s perspective, deferred revenue is a double-edged sword:
- Positive signal: It indicates strong customer demand and cash flow predictability.
- Accounting liability: It represents a future obligation to deliver service, which the buyer must fulfill post-close.
Because of this, deferred revenue often becomes a focal point in due diligence, working capital negotiations, and purchase price allocation.
Key Considerations When Presenting Deferred Revenue
1. Align GAAP Treatment with Buyer Expectations
Buyers—especially private equity firms and strategic acquirers—expect deferred revenue to be recognized in accordance with GAAP (ASC 606 for revenue recognition). If your company uses cash or modified accrual accounting, you’ll need to reconcile your financials to GAAP standards early in the process.
For example, if a customer prepays $120,000 for a 12-month SaaS subscription, GAAP requires you to recognize $10,000 per month as revenue and record the remaining $110,000 as deferred revenue. Misalignment here can lead to disputes over EBITDA adjustments or working capital targets.
2. Provide a Deferred Revenue Rollforward
Buyers will want to understand how deferred revenue has changed over time. A rollforward schedule should include:
- Beginning deferred revenue balance
- New billings (prepaid contracts)
- Revenue recognized
- Ending balance
This helps buyers assess revenue quality, churn, and billing practices. It also supports the buyer’s financial model and informs purchase price allocation.
3. Clarify the Relationship Between Deferred Revenue and Cash
One common point of confusion is whether deferred revenue is “backed” by cash. In most SaaS businesses, it is—customers prepay, and the company holds the cash while recognizing revenue over time. However, if cash has been spent or reinvested, buyers may view the liability as a future cost without a corresponding asset.
To address this, sellers should present a clear reconciliation of deferred revenue to cash balances and explain any timing differences. This is especially important when negotiating working capital adjustments or determining whether deferred revenue should be included in net working capital or treated as a debt-like item.
4. Prepare for Purchase Price Allocation Negotiations
In an asset sale, deferred revenue can become a flashpoint in purchase price allocation. Buyers may argue that they are assuming a liability (the obligation to deliver service) and should receive a corresponding reduction in purchase price. Sellers, on the other hand, may argue that the cash has already been received and used to grow the business.
There’s no universal rule here—it often comes down to negotiation. However, sellers who proactively model the impact of deferred revenue on purchase price allocation and present a defensible position are better equipped to preserve value.
Firms like iMerge help clients navigate these discussions by preparing detailed financial models and supporting documentation that align with buyer expectations and accounting standards.
Common Pitfalls to Avoid
- Inconsistent revenue recognition: If your revenue recognition policies are not applied consistently, buyers may question the integrity of your financials.
- Understating deferred revenue: This can inflate EBITDA and lead to post-close disputes or earn-out clawbacks.
- Failing to disclose multi-year contracts: Buyers need visibility into contract terms, renewal clauses, and billing schedules to assess future revenue streams.
As we noted in Completing Due Diligence Before the LOI, early transparency around financial metrics—including deferred revenue—can reduce friction and build buyer confidence.
Best Practices for Sellers
To present deferred revenue effectively during an M&A process, consider the following best practices:
- Adopt GAAP-compliant revenue recognition policies well before going to market
- Prepare a deferred revenue rollforward and tie it to your financial statements
- Reconcile deferred revenue to cash and explain any variances
- Model the impact of deferred revenue on working capital and purchase price
- Engage an experienced M&A advisor to guide negotiations and defend your position
These steps not only reduce the risk of valuation erosion but also demonstrate operational maturity—an important signal to sophisticated buyers.
Conclusion
Deferred revenue is more than an accounting line item—it’s a strategic lever in the M&A process. When presented clearly and proactively, it can reinforce the strength of your business model and support a premium valuation. When mishandled, it can become a source of friction, delay, or even price reduction.
Whether you’re preparing for a full exit or exploring strategic options, understanding how to present deferred revenue is essential. And with the right guidance, it can become a point of strength rather than contention.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
