Protect your position before it is too late.
Failure to address issues related to closing purchase adjustment before the execution of a transaction can lead to contention at the day(s) of reckoning, typically 30 to 60 days after the ink has dried.
Imagine this setting: You are an M&A professional for an acquiring firm, and you’ve gone to the wall to make a transaction happen as seamlessly and advantageously for your company as possible. However, four or five months later, you are saddled with the responsibility of settling a several-million-dollar dispute between your company and the seller over the closing purchase adjustment. The dispute leaves you unable to focus the necessary energy on executing your firm’s M&A strategy or integration. It is all the more frustrating when you realize—with the benefit of hindsight—that the enduring saga could have been avoided had proper steps been taken early in the transaction process.
In the overall universe of executing a deal, the closing purchase adjustment can seem to be nothing more than an afterthought, because “boiler plate” language exists that can easily be inserted into a draft purchase agreement. Accordingly, the closing purchase agreement can remain somewhat “forgotten” throughout the negotiation process, while larger issues are tackled.
The nature of closing purchase adjustments vary significantly from transaction to transaction. However, as a baseline, it is typical for the parties to compare the seller’s working capital or net assets at the closing of a transaction to its working capital or net assets at a designated earlier point. The difference between the two amounts results in a payment to the buyer or seller, depending on the nature of the adjustment (i.e., net assets higher at close than at an earlier point – funds due to seller, and vice versa).
Consider taking the following steps early in the process and throughout the deal to help your company avoid financial loss and acrimony at the tail-end of the transaction:
Perform initial and ongoing assessment of financial data and accounting resources of the target, including the following:
Does the target have audited financial statements performed by a reputable firm? If so, what is the nature and amount of any audit adjustments? Has a management letter been issued? If not, does that comport with subsequent due diligence findings?
Continue to assess competency of the target’s accounting staff throughout the due diligence phase.
Assemble and dispatch your financial due diligence team early. Give them as much lead time as possible to see what discrepancies might actually be crawling under the rocks.
Don’t just consider due diligence findings strictly as they relate to base purchase price; think also about the impact to the closing purchase adjustment, and negotiate accordingly. Remember, items that you find (or don’t find) in this regard can directly accrue to your benefit (or detriment) on a dollar-for-dollar basis.
In instances where there could be ambiguity based on findings and initial “boiler plate” purchase agreement language, negotiate with the other party to “paper” the purchase agreement, in order to gain as much clarity as possible and to protect and strengthen your position.
Schneider Downs provides accounting, tax and business advisory services through innovative thought leaders who deliver the expertise to meet the individual needs of each client. Our offices are located in Pittsburgh and Columbus.
This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.