During a transaction, players work furiously to capture the greatest value. But with so many people constantly (and quickly) updating the details, it’s easy for things to get missed. If an organization’s finance team doesn’t have the dedicated resources, time or expertise to carefully review each draft of the purchase agreement, provisions affecting the purchase price might not get the scrutiny they should—and that can lead to major issues, including post-closing disputes. Whether an organization has been through many deals or this is the first, it can take pre-close steps to help avoid a post-close fight.
1. Address front-end factors regarding agreements. The simplest way to avoid issues post-close is to make sure teams are not operating in silos. The finance team is not always involved with all the deal-related discussions, especially involving agreements. In fact, sometimes even the CFO doesn’t have visibility into purchase price agreement updates. Often, it’s the attorneys and sponsors who make changes that can seriously affect the overall upside or downside in the post-close process. Because the finance team is likely accountable for some of the results of the language in these agreements, it should demand a seat at the table during negotiations and have a point person involved with all calls, reviews and changes.
2. Frame up the definitions of working capital. With so many ways to structure a deal and define working capital, a company should understand all options up front and take the time to analyze each so it is not leaving any money on the table. Typically, a target amount is set based on the working capital—for example, $15 million. After closing, the team will review and make dollar-for-dollar adjustments based on the final delivered working capital. However, setting a range is becoming more common. For example, a $13 million to $15 million range might be set and not adjusted unless the working capital goes outside that range. Or, if the company is looking at purchasing a growing business, the seller might see incredible potential for revenue growth—but if the buyer doesn’t see that same value, a range can help bridge the gap. The deal parties also can consider bridging that gap through an earnout.
3. Think about potential earnouts. A variety of ways exist to structure earnouts that can be advantageous to all parties. In each case, the agreement will include the definitions of that earnout, which outline the methodology and thresholds, what’s included and excluded, and restrictions on bookkeeping and business practices. A buyer will want to consider its plans for the company and factor those into how it structures the language. For example, the buyer might decide to pay a defined purchase price at close, with the option to pay the seller more at a future date depending on company performance. In a graduated earnout, tiered amounts of earnout could be based on revenue. For example, if the company hits $150 million, the seller gets $5 million, but if it hits $200 million, the seller gets $7 million. A cliff earnout is more definitive, because if the company doesn’t hit or exceed the target number, no earnout is paid. It’s important to understand the pros and cons of each option in a specific situation.
4. Factor in pre-close accounting. Some buyers might not have the time, resources or knowledge base to dig into past account balances and other financials of the target company. And if those financials are accepted at face value and make their way into the target’s working capital, the buyer might not find out until post-close that a certain account balance is not what was expected. By that point, the buyer will have to expend extra time and effort to initiate a post-closing dispute and still might not be successful in obtaining a purchase price reduction. Ultimately, the responsibility falls on the buyer to look at or understand every single material account before the purchase, which might not be possible given timing and resources. In addition, in some cases, a CFO or person in another accounting role from the target company might not be the best person to identify these types of adjustments that favor the buyer, as legacy seller employees might have economic interests in the company being sold. So it’s important to determine whether anyone in charge of accounting has incentives to find potential upsides or downsides either way.
Most transactions are an intense and time-consuming process, even without the extra effort of a post-close dispute. Taking the time up front to determine whether a company has the resources, knowledge base and time to manage a transaction (especially on top of all other duties) is one of the best ways to help avoid that extra effort and get the deal done sooner and without lingering areas for resolution.
