Page 31 - M & A Disputes

Chapter 2

Postclosing Purchase Price Adjustments

Overview

Working capital and net asset adjustments are adjustments made to the agreed-upon purchase price.
These adjustments are included in acquisition agreements to address changes in the target’s financial po-
sition between the time of the preliminary agreement or letter of intent signing and the transaction clos-
ing. The closing balance sheet typically differs from those balance sheets provided to the buyer during
negotiations as a result of the ongoing operations of the business. Therefore, most agreements include a
section dealing with postclosing adjustments. As previously stated, the postclosing adjustment provision
attempts to account for changes in the target’s financial position, often its working capital, between the
preclosing (sometimes referred to as the target or reference) balance sheet fn 1 and the closing-date bal-
ance sheet. This provision can protect the buyer from potential seller abuses, such as removing working
capital from the target company before the close of the transaction. This agreement section often re-
quires the buyer to prepare a final closing balance sheet after the transaction has closed and compare the
values of certain balance sheet accounts or metrics (such as net assets or working capital) to the values
reflected on the reference balance sheet. If the working capital or net asset value increases, the buyer
may be required to make payment to the seller in addition to the stated purchase price. However, if the
working capital or net asset value decreases, the purchase price may decrease by the corresponding
amount. Typically, postclosing adjustment sections of agreements require a dollar-for-dollar adjustment
to reflect changes in the working capital or net asset values between the preclosing (reference) balance
sheet and the closing balance sheet. However, some agreements may not require a payment unless and
until any differences reach an agreed-upon threshold.

Presented subsequently is an example of a purchase price adjustment provision. In this example, the
purchase price adjustment is based on working capital, and the buyer is responsible for preparing the
closing balance sheet.

Section 1.8Purchase Price Adjustment

(a) Within sixty (60) days following the Closing Date, Buyer shall prepare a closing state-
ment (the "Closing Statement") setting forth the Working Capital as of the Closing Date
(the "Final Working Capital"). The Closing Statement shall be prepared in accordance
with GAAP applied on a consistent basis.

(b) If the Final Working Capital is equal to the Target Working Capital, then no adjustment
to the Purchase Price shall be made. If the Final Working Capital exceeds the Target
Working Capital, Buyer shall pay to Seller the amount by which Final Working Capital
exceeds Target Working Capital. If the Target Working Capital exceeds the Final Work-

fn 1 For purposes of this practice aid, the balance sheet used to set the target working capital is referred to as the reference balance
sheet. However, in many instances, the target working capital is based upon the average working capital balances reflected in the bal-
ance sheets of several months or even the prior 12 months, as opposed to any single point in time.

© 2020 Association of International Certified Professional Accountants 29