Page 47 - M & A Disputes

Bundled Product

Dealing with bundled products may also be a cause of dispute. Bundled products refer to a combination
of products originated from a buyer and seller. If the target is to be integrated into the buyer’s existing
business, distinguishing the revenue and profits from bundled products can be problematic.

For example, let’s suppose that a product sold by the target prior to acquisition was enhanced with new
product features by the buyer, and the buyer also provided installation and customer support not previ-
ously provided by the target. A dispute may arise related to the amount of revenue attributable to the
product previously sold by the target versus the enhancements and additional services. A dispute may al-
so arise related to the amount of production overhead costs from the manufacturing facility allocated to
the product.

Recordkeeping

After the closing, the operations that drive the earnout are often integrated into the buyer’s existing
business. In addition, tracking the operations that drive the earnout may be difficult. Often, after the in-
tegration, the accounting records are not kept in a manner consistent with past practice, as is commonly
required by the acquisition or earnout agreement. Not only are the accounting records frequently not
prepared in a manner consistent with past practice, but it is also unusual for stand-alone financial state-
ments to be prepared during the normal course of business in accordance with the earnout provision be-
cause the earnout provision usually requires the preparation of special purpose financial statements to
meet specific contractual terms.

In other cases, the earnout provision may require carving out a portion of the business that did not exist
prior to the closing, or the buyer may change the target’s accounting system. Such a change may cause
difficulty in gathering the information necessary for the earnout calculation.

Other recordkeeping challenges may arise as a result of company personnel situations. For example, the
CFO or other financial personnel of the target may stay with the target and feel left behind by the seller
and seek revenge against the seller by presenting recordkeeping and access difficulties for the seller.

For these reasons, some earnout provisions require the operations that drive the earnout to be tracked
separately in the accounting system. Alternatively, some earnout provisions require the periodic report-
ing of results, so that the seller can ensure that information necessary for the earnout calculation is
tracked and can be reported appropriately. It is also not uncommon for the seller to have inspection or
audit rights of the accounting records.

Postclosing Oversight

Because the postclosing operation is often managed by the buyer, it is also common for the seller to re-
quest a degree of oversight during the earnout period to prevent the buyer from taking extraordinary ac-
tions. In other cases, it is not unusual for the seller to remain involved with the postclosing operation be-
cause the target’s operational growth depends on the talent of the principal seller. In such a case, the
buyer often needs to be more involved with the oversight of the seller’s activities because the seller’s
motivation may not be in the best interest of the acquired company and the buyer. For example, a seller
charged with running the business postclosing in an earnout situation when the earnout is based on reve-
nue may be inclined to deeply discount product prices in an effort to boost sales. Such a price discount
may not result in a corresponding increase or, perhaps, may result in a decrease in profitability. In such

© 2020 Association of International Certified Professional Accountants 45