Page 48 - M & A Disputes

instances, the buyer may exercise some control by requiring limitations regarding pricing discounts or
the buyer’s approval of discounts in excess of X%.

Other

Other issues may arise due to a lack of clarity in the earnout provisions. For example, when the earnout
period is not specifically defined, a dispute may arise involving the use of the year-end date versus the
anniversary date. As discussed in chapter 2, because most companies apply more rigorous and in-depth
closing procedures at year-end versus interim periods, issues may arise regarding the determination of
accrued vacation expense, physical inventory count adjustments, and so on.

Another issue may arise due to changes in accounting rules. If the earnout provision provides for net in-
come prepared in accordance with GAAP, the use of a new accounting rule may affect the earnout ad-
justment. For example, FASB Accounting Standards Codification (ASC) 820, Fair Value Measurement,
significantly changed practices for some entities after 2007.

Other less-pervasive changes can also have a significant impact on the ultimate earnout payment. One
common issue is a decision by postclosing management (either the buyer or seller who remained with
the target to manage the operation) to accelerate or delay shipments to customers. Because revenue
recognition often depends on the timing of shipments to a customer, changes in the specific timing of
fulfilling orders, particularly at or near the end of the earnout period, can affect the earnout calculation.
This is especially true if those customer orders drive the difference between achieving and falling short
of meeting a threshold established by the earnout provision.

Other postclosing business decisions, such as a subsequent settlement of litigation on less-than-favorable
terms or providing excessive employee bonuses can also affect the earnout adjustment calculation.

Some other issues that may affect earnout calculations are allocations of corporate overhead, related-
party transactions that may not be at arm’s length, and increased depreciation expenses due to purchase
accounting asset valuations.

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