Page 11 - M&A

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Mergers & Acquisitions | MONDAY, OctOber 26, 2015 | S11
Accounting
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ACh payments issued by the acquired busi- ness but not yet cleared or settled.
Types of Adjustments and Procedures
working capital adjustments may be two- way (i.e., up or down; this is most common) or one-way (only up or only down) or capped, banded, subject to a basket or dollar-for- dollar (most common). Adjustments also typically take the form of a single-step or two-step process.
The purchase agreement will typically provide that the buyer will have some num- ber of days after closing to deliver a “closing statement” setting forth its calculation of, among other things, working capital and the components thereof. This is common in both a one-step and a two-step process. In a single step process, the buyer pays the purchase price on the assumption that closing date working capital equals target working capital and then calculates clos- ing date working capital after closing. In a two-step process, one of the parties—typi- cally the seller—will deliver an “estimated closing statement” shortly before closing, and the amount the buyer pays at closing will be adjusted accounting for deviations from target working capital (as reflected in the estimated closing statement). The second step follows the buyer’s delivery of the closing statement. In such case, the
buyer calculates the closing date work- ing capital but compares such calculation against what was paid at closing and a true- up payment is then made by the buyer or seller, as applicable. Two-step adjustments are prevalent. They reduce the likelihood of large true-up payments, particularly in scenarios where a significant amount of time passes between signing and closing. Such a mechanism may, however, open the door for gamesmanship on the part of seller. In light of the foregoing, M&A counsel needs to consider the inclusion or absence of review and comment rights, interest payments, tim- ing and escrows.
Review Periods
Appropriate review periods also need to be negotiated. often the failure to timely deliver a closing statement will result in deemed accep- tance of the seller’s position and the failure to timely object will result in the deemed acceptance of the buyer’s position. Accord- ingly, the parties need to consider such timing implications in negotiating appropriate review periods and ensure appropriate access to records. In addition, the purchase agreement should specify the requirements for a prop- erly delivered closing statement and objection notice. The purchase agreement should also address whether undisputed amounts should be released from escrow or otherwise paid over prior to the final resolution of working capital.
Dispute Resolution
The purchase agreement should provide detailed procedures for addressing purchase price adjustment disputes between buyers and sellers. Typically, there is a period of
time (e.g., 30 days) allotted for the parties to negotiate in good faith. After such period has expired, it is common for the dispute to be settled by a neutral accounting firm. The neutral can be named in the purchase agree- ment or can be selected pursuant to an agreed procedure. In either case, such neutral will typically be independent and not the account- ing firm used by buyer or seller in the ordinary course. The parties should also determine whether the neutral should function as an independent expert and not as an arbitrator. If deemed an arbitrator, M&A counsel needs to determine whether there are unintended consequences regarding procedure and scope of review, including the implication that the neutral is to make decisions with respect to legal issues, such as liability.
The neutral should be required to make its determination solely based on the account- ing methodologies and definitions specifi- cally set forth in the purchase agreement and should not make any determinations with respect to matters not in dispute, including any independent evaluation of the appropri- ateness of target working capital. Further- more, the parties should decide on the scope of permissible review and objection. The purchase agreement or engagement letter should also address whether the neutral will be entitled to review the parties’ work papers or request additional information. whether the neutral must resolve disputed items within the range asserted by the par- ties or whether some other procedure, such as baseball style arbitration, must be used (which, although less common, arguably
disincentivizes overly aggressive positions) should also be specified.
Exclusivity of Remedy
Given the financial complexity involved, deal parties often prefer that all purchase price adjustment disputes, including whether the proper working capital calculation meth- odology was used, be resolved solely by the neutral and not in a court proceeding. Accordingly, such intent should be stated in the purchase agreement with precision and M&A counsel should carefully consider whether any other provisions, including exclu- sive remedy components of indemnification provisions, may allow a judge or arbitrator to decide such dispute.
once the working capital adjustment, if any, is finally determined, the relevant amount will need to be paid to the appli- cable party. The purchase agreement will need to address the timing of such payment, the source of such payment and the rate of interest payable (if any). A portion of the purchase price is often placed into escrow to serve as a source of recovery for pur- chase price adjustments. Sometimes only one escrow is provided and payments there- from serve to reduce proceeds available to satisfy indemnification claims. In other cases, there may be a separate adjustment escrow. other possibilities include holdbacks, set-off rights (particularly if there is an earn-out) or simply an obligation to pay. Counsel should consider whether or not such arrangements constitute a cap on recovery and whether the mechanics provide an incentive to manipu- late working capital estimates.
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