Attaching a sample NWC calculation as a schedule to the purchase contract can also be very useful in minimizing disputes. Learn how both parties to a business acquisition can protect the value of their transaction from pre-closing working capital fluctuations. The parties must also define the elements included and excluded in the adjustment and the accounting methods and procedures used in the calculation of those elements. Editorial errors can lead to costly post-closing litigation and material losses. Lawyers should work with management, accountants and financial advisors to prevent manipulation or dispute on these points after closing. This second part of the new set of warnings (with Part I on McGuireWoods` “Password Protected” blog) focuses on purchase price adjustments for buyers and sellers in technology transactions, but also applies to most other industries. Read on for a discussion on the veracity of the purchase price, including the basis of the adjustments, the mechanisms for calculating the adjustment, the motivations of each party, and risk management. Another important and sometimes contentious issue is the definition of the elements included and excluded in the adjustment and the accounting policies and procedures to be used in the calculation of these elements. This is a crucial step. Inattention to these details and mistakes can lead to costly disputes after closing and significant economic losses. It is essential that the parties` lawyers, management, accountants and financial advisors work closely together as a team to draft and negotiate these provisions, paying particular attention to those points that could be manipulated, misinterpreted or challenged retrospectively. While earn-outs are present in a minority of transactions in the U.S.
and Canada, balance sheet adjustment provisions were present in 95% of selected U.S. private M&A transactions signed in 2018 and Q1 2019 (the transactions studied). This figure is higher than in any other investigation period in the last decade. Of the adjustment provisions in the transactions studied, more than 90% used working capital as the chosen financial measure, with the other less popular options being debt, cash and assets. Working capital is a flexible measure that is usually calculated by deducting current liabilities, such as commercial debts. B, current assets such as cash and receivables. This is the most popular adjustment because current assets and liabilities are likely to show the greatest fluctuation over the adjustment period. The NWC`s calculation should exclude assets and liabilities that are not transferred as part of the sale or that have no economic value after the closing of the financial statements (p.B. certain tax positions). It is preferable to agree on a detailed schedule of accounting methods and procedures for items that are particularly contrary to opinion, such as.B. Inventories, reserves for uncollected accounts, reserves for contingent liabilities, provisions for paid leave and bonuses, pro-rated expenses and other industry-specific issues of the target company.
The seller will also want to exclude all possibilities for the buyer of “double dip”. A double dip would occur if the buyer claims the same items both in the post-closing adjustment and under the indemnification provisions of the agreement. Seller must also ensure that no items were counted twice in the initial purchase price adjustments for debt and the initial NTA or NWC adjustment at closing. Buyers, sellers, their advisors and other advisors sometimes give little flexibility to adjustment provisions after the closing time of M&A transactions. However, it is important to ensure that the language and calculation methods are clear and do not open the door to opportunistic behavior after closing. Getting it right requires teamwork and paying close attention to detail from everyone involved. 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.
For most adjustments, the buyer and its accountants create a detailed calculation of the post-closing adjustment and deliver it to the seller within a certain period of time after completion. 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. In the event of an adjustment to the purchase price of working capital, the buyer will attempt to ensure that he receives a minimum level of working capital in order to avoid having to deposit money into the business to finance the working capital requirement after closing. The adjustment also reduces the seller`s incentive to manipulate working capital by speeding up debt collection, delaying accounts payable, or otherwise maximizing cash that can be distributed to the seller prior to closing. From the seller`s perspective, it typically receives payments from unusually positive fluctuations in the NWC, which would otherwise give the buyer a shot of luck in the form of excess working capital.
For most of the United States. Mergers and acquisitions will operate the business until closing for the economic benefit of the seller (and at the seller`s own risk). For technology transactions, purchase price adjustments can generally be based on income or expenses or on a net tangible asset (NTA) adjustment (in software transactions). The main purpose of the adjustment is to protect the buyer from any depreciation between the time of the conclusion of a purchase price for the target transaction and the closing. Adjustment At the time of closing, it is almost impossible to determine whether the seller has actually delivered an amount of working capital equal to the target amount to the buyer. Indeed, it often takes some time for a balance sheet to be reconciled to determine the amount of working capital for a given day. .
