For example, if the target NOC is $1,000,000, but the actual working capital at closing is only $700,000, the seller will pay or credit the buyer with an additional adjusted purchase price of $300,000. Most (but not all) adjustments are “bidirectional” and adjust in favour of the seller if the actual NOC exceeds the NOC`s target. For example, in the previous example, if the closing of NWC was $1,300,000, the buyer paid the seller the $300,000 deductible as an adjustment to the purchase price to account for this difference. Post-closing purchase price adjustments are sometimes based on income, expenses, assets and liabilities in addition to or in place of standard NOC components, such as . B net assets. Some adjustments reward the seller with additional payments that depend on the future performance of the acquired business. The following mainly concerns adjustments to the purchase price of the NWC. 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”. 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. Submission of the calculation of the closing working capital. Upon closing, the buyer or seller has a fixed period to provide the other party with a calculation of the closing working capital as well as the calculation of the adjustment resulting from the purchase price by the submitting party. 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 approval of estimated adjustment The NOC`s adjustment also reduces the seller`s incentive to manipulate working capital by accelerating debt collection, delaying liabilities and taking other steps to maximize liquidity distributable to the seller prior to closing. Adjustment time. Since it takes time to determine the working capital of the target company with a significant degree of accuracy at the reporting date, most purchase price adjustments are made after closing.
However, if, at or before closing, the parties consider that the working capital of the target entity is likely to be materially different from the benchmark, whether upwards or downwards, they may agree on an adjustment to the purchase price calculated at closing on the basis of the best estimates of the target company`s closing working capital portions. Creating the initial adjustment calculation. According to ABA studies, the buyer now almost always prepares the first purchase price adjustment calculation after completion (if one is to make one). This was the approach for 99% of applicable transactions reported in the 2019 study. Preparation for the calculation of the initial adjustment Deferred tax assets and deferred tax liabilities reflect temporal differences in which certain income and expenses are recognised differently for income tax and accounting purposes in accordance with generally accepted accounting principles. Current shares of deferred tax assets and liabilities are part of the traditional definition of working capital. Determine whether deferred tax assets and deferred tax liabilities should be explicitly excluded from the definition of working capital. If these items are not excluded from the definition of working capital, determine the impact this will have on the inclusion of deferred tax assets and liabilities in the estimated balance sheet at closing and in the actual closing balance sheet. “Working capital shall be calculated at the balance sheet date in accordance with generally accepted accounting principles (`GAAP`), which shall be applied uniformly. If the working capital is greater than x US dollars, the purchase price will be increased by the amount of this excess. If the working capital is less than x United States dollars, the purchase price is reduced by the amount of this deficit. (b) Although GAAP is commonly used as a standard, it does not clearly establish a final assessment for each individual component of working capital. GAAP recognizes many different accounting policies that are acceptable to consider the same element.
It is useful that the above purchase price adjustment provisions state that GAAP must be applied consistently. However, auditors still have a lot of leeway, as .B. Materiality standards for litigation, environmental issues, adjustments to a particular account that is part of working capital, or issues that arise after signing if the target company does not have a previous established practice to apply them consistently. Conclusion Many provisions of a M&A purchase agreement reflect a division of risk between seller and buyer, including provisions relating to financial matters, compliance, labor and employment, benefits, contracts, business activities in the ordinary course of business, securities, and the adequacy of the company`s assets. (h) Consider including language to address double counting, such as: “Under no circumstances may a component of working capital, debt or remuneration be counted twice as part of such a category. » Procedure for handling a dispute. When a dispute arises, the purchase agreement often requires the parties to first try to resolve their disagreements between them within a certain period of time. Any dispute that cannot be resolved within the specified time limit will usually be sent to a third party in an out-of.B-court setting, for example to a nationally recognised accounting firm or other professional expert with knowledge of the relevant sector.
The parties may agree and identify the third arbitrator in the purchase contract, or the purchase contract may specify the procedures for selecting one or more arbitrators, as there may be several. Payment of the amount of the adjustment shall be due as soon as the amount of the adjustment has been agreed or finally determined by the accounting arbitrator. For some transactions, part of the purchase price is deposited to guarantee payment of an adjustment due by the seller. Sometimes the agreement also provides for interest to be charged on unpaid adjustment amounts in order to avoid late payments. Once the parties to the transaction have agreed on a purchase price, often subject to satisfactory completion of due diligence or other conditions by the buyer, lawyers are often advised to recall three aspects relating to the purchase price: (g) What happens should be taken into account if the party responsible for preparing the calculation of the final purchase price does not or does not do so. when preparing such a calculation. is timely.. .