November 15, 2016
The parties have shaken hands. The contract has been signed. The transaction has been finalized. And then it happens: there is a post-close disagreement about the previously agreed purchase price. So how do parties that spent weeks or months in due diligence end up in a dispute? While both parties involved in a deal might agree on a base price, contracts generally allow for a post-closing purchase price adjustment based on the acquired assets and liabilities as of the closing date.
A significant risk to a transaction is that a party has either put up too much money or received too little. Neither side wants that, and it often leads to purchase price disputes (PPD). Such disputes can be costly for both parties. Resources are diverted to deal with arbitration or, even worse, litigation–just when it is most critical to focus on integration activities. Sometimes negotiations can drag on for a long time, or even more troubling, protracted disputes can shake the confidence of investors.
Following are some measures that parties involved in the transaction should consider up-front in order to potentially minimize the chances of a PPD.
Make the closing date work for both parties. Setting the closing date at the end of the month or end of the quarter makes for an easier transition from seller to buyer. For example, if the closing date occurs on the sixth day of the month, the parties would need to pro-rate all monthly expenses and accruals to account for the days of the month the seller owned the company compared with the days that the buyer owned it. This can be a very tedious and time-consuming exercise. By setting the closing date at the month or quarter end, you can help mitigate the monthly cut-off concerns which often lead to disputes.
Dot your i’s and cross your t’s. The more specific the parties can be when drafting the agreement, the lower the likelihood there will be a disagreement over the terms of the contract. For example disputes often arise regarding whether generally accepted accounting principles (GAAP) or consistency – that is, in a manner consistent with how the company has performed its accounting in the past – takes precedence in applying an accounting method to a particular transaction. It is therefore important to explicitly state in the sales and purchase agreement (SPA) whether GAAP or consistency is the prevailing accounting method in the event they conflict.
Avoid double trouble. Be careful about having specific inclusions or exclusions for selected accounts such as cash, debt, or income taxes, while at the same time allowing for other adjustments, such as net working capital, that may end up overlapping. Say, for example, the agreement states that the seller will indemnify the buyer for a piece of outstanding litigation. After closing, the buyer pays $50,000 to settle the litigation, and demands that amount from the seller under the indemnity. If the buyer had also included a $50,000 reserve in the closing balance sheet, the seller would effectively be penalized twice for the litigation – first under the indemnification and then through a post-closing working capital adjustment.
Count your chickens. Buyers naturally want to ensure that all of the assets they are paying for are there when the transaction closes, and that they are valued appropriately. For example, inventory can be a commonly disputed item. Such a dispute can be minimized if both parties observe the physical inventory count done on the closing date. Parties should also agree on procedures that will be used to verify the existence of certain high-value property, plant, and equipment.
Decide who sees what. Parties need access to certain books and records in order to determine the final purchase price. But will they have access to what they want to review? This is especially important for sellers if they no longer hold the books and records once the transaction is complete. Parties should ensure adequate language is included in the SPA to mitigate the risk of one party not having sufficient access to books, records, and key personnel. Language should be specific regarding the ability to obtain electronic files, such as the general ledger system or other native files.
Decide what is material. If the contract is silent regarding when a dispute is considered material, then anything is fair game. Buyers and sellers can potentially reduce the risk of a dispute by agreeing to definitive thresholds for materiality in the SPA that relate to post-closing disputes (i.e., by setting a dollar threshold that must be exceeded before disputed amounts can be asserted.)
These are just a few common examples of the many issues that can spark a PPD. Involving M&A Dispute advisors knowledgeable about these common issues and other not so common issues early enough in the closing process can help the parties address these issues before disputes arise. Also, involving advisors with the preparation of the estimated closing statement and closing balance sheet can potentially help ensure that contract terms are applied appropriately and that both parties receive the benefits of their bargains.
To discuss strategies for avoiding a post-deal dispute, contact Doug Branch, Frank Dery, or Ashley Davis. Visit our PwC Deals site for additional thought leadership on trends and opportunities impacting today’s deal environment.