Where an adjudicative accounting firm is engaged, the parties should consider any potential conflict of interest and determine whether the appointed firm`s fees would be proportionate to the expected amount of a disputed adjustment. The powers of the designated accounting firm should be limited solely to the elements at issue and to the settlement of the disputed elements in the context of the value claimed by the parties. The arbitrator`s decision on the disputed items and the amount of the adjustment is generally final and binding. As a general rule, the arbitrator`s fees are distributed in proportion to the amount of the disputed adjustment decided for and against each party. Setting the reference amount In the example above, the working capital reference amount is called target working capital, which is often a fixed amount that the parties agree on during negotiations. However, it is not always easy to get the parties to agree on the point of reference. For example, the parties may attempt to determine the amount of reference working capital from the date the transaction was “valued”. However, this is often easier said than done, as it is often not clear when the buyer has evaluated the transaction or when exactly the parties have agreed on the price. Was it when the letter of intent was signed, when the buyer did their first financial due diligence, or at some other time? Parties should avoid language that simply states that items must be determined “in accordance with GAAP” (generally accepted accounting principles), as GAAP often permits the use of a range of accounting policies. It is important that the seller ensure that the adjustment elements are calculated in accordance with the seller`s prior accounting practices for these items. The seller wants an “apples with apples” comparison of the final NOC and does not want the buyer to get a more favourable adjustment by changing the accounting rules. Typical post-closing adjustment provisions focus on the target company`s liabilities and assets that fluctuate due to business activity between the time the parties agree on a purchase price and the actual closing of the transaction, which may be months after the initial price agreement.
The most common adjustments are based on the difference between the target company`s actual net working capital (NOC) at closing and an agreed NOC target amount expected at closing. True-Up before closing. Increasingly, mergers and acquisitions by private companies involve an estimated purchase price adjustment that is true at closing. ABA studies show this trend and occurred in 97% of transactions in 2019, 86% in 2017, 89% in 2015, 88% in 2013, 85% in 2011, 76% in 2009 and 64% in 2007. The determination of the purchase price of a private merger and acquisition transaction is an integral part of the commercial negotiation and therefore of the purchase contract. In the UK, the two approaches normally used to calculate the target transaction price are either a balance sheet adjustment or a locked box mechanism. While a closed balance sheet adjustment mechanism may be the most common approach, the locked box mechanism is increasingly becoming the preferred route from a seller`s perspective, especially for private equity or other financial sellers where it is crucial to be able to return value to stakeholders. We are also seeing more and more locked box mechanisms used in non-UK transactions. Purchase price adjustments reflect changes in the target company`s agreed purchase price, which typically occur between the signing of the letter of intent or acquisition agreement and the closing date. These price adjustments will be made after completion, when the key date figures will finally be determined.
There may be delays between the initial determination of the purchase price and or after closing for many reasons, such as. B hart-Scott Rodino, other regulatory approvals, third party approvals, ongoing buyer due diligence, tax matters, litigation and changes in the Company`s financial condition. The parties would then make a second adjustment after closing using the adjustment to the financial statements as a reference. For example, if the purchase price is $100 and the initial target (reference) working capital is $10, and the parties agree before closing that the final level of working capital is likely to be closer to $25 instead of making the full adjustment after closing, they may choose: adjust the purchase price payable at closing to $115, to reflect the likely additional $15 in working capital ($25 to $10). and after completion, make an adjustment that uses $25 as a new benchmark for working capital. Since most (but not all) of the NOC`s adjustment formulas require payment to the seller if the NOC`s closing exceeds the target, the NOC`s adjustment protects the seller against exceptionally positive fluctuations in the NOC that would otherwise give the buyer a chance in the form of excess working capital. This preserves the underlying assumption in most of the United States. M&A treats that the business is operated for the economic benefit of the seller (and at the risk and peril of the seller) until closing. Buyer`s right to approve the estimated adjustment.
Increasingly, there is no explicit right of the purchaser to approve the estimated adjustment to the financial statements. In the 2019 ABA study, 89% of transactions with closing estimates did not have such an explicit right, compared to 84%, 84%, 74%, 68%, 59% and 66% in the previous six studies. Buyer`s right to approve the estimated adjustment Most U.S. private company M&A transactions have a mechanism to adjust the price after closing to more accurately reflect the agreed value of the acquired business at the balance sheet date. Buyers, sellers, their attorneys and other consultants should pay particular attention to the post-closing adjustment provisions and related procedures of the purchase agreement to ensure that these terms express the intentions of the parties, that the language and methods of calculation are clear, and that they do not open the door to disagreements and opportunistic behavior after closing. Getting it right requires teamwork and paying close attention to detail from everyone involved. In addition, a locked box approach can make it easier for a seller to compare bids at an auction, as bidders are asked to provide a fixed price based on a series of locked box date accounts provided by the seller in the due diligence information. However, adjustments to the purchase price are considered neutral between the parties. These provisions are linked to the purchase price, often dollar for dollar, in an easily calculable manner and shortly after closing. While adjustment provisions are generally quite simple, they are nevertheless important to ensure that the parties achieve the economic outcomes they have negotiated.
However, not all transactions between the target and a member of the seller group are inadmissible, and the parties must also identify possible “admissible leaks”. There is usually no reason why market-based trading between the target company and the group of sellers, which are valued fairly, should not continue, at least until closing. Leaks considered by the buyer to be greater than fair value or a transfer of value to the seller may also be authorized by the buyer, provided that they are visible and secure at the time of signing and that there is a corresponding reduction in the purchase price. Purchase price adjustments for changes in working capital are adjustments to working capital accounts between what the parties know and appreciate at closing and what becomes known after closing when the target company`s books are closed. Most M&A transactions involving post-closing purchase price adjustment provisions require the seller to calculate an estimated adjustment immediately prior to closing. This estimate is used to determine final payments. .