Page 60 - M & A Disputes

ings stream that is used by the parties when determining the purchase price; however, other common
metrics are revenue, earnings before interest and taxes (EBIT), NOI, and net income. fn 2

The pricing multiple is derived based on an analysis of guideline company and recent transactional data.
Pricing multiple analysis establishes, after suitable adjustments (such as when financial characteristics
are not similar to the subject in size and growth potential), what similar assets or businesses have been
sold for in the past. When evaluating guideline company or transaction pricing multiples, a practitioner
should consider operations, products, services, distribution, cost structure, geography, or customers and
financial aspects, such as sales (by market capitalization, earnings, book value of assets, or sales); mar-
gins; growth; and profitability of the guideline companies. The pricing multiple is then applied to the
target’s EBITDA to determine the purchase price.

The market and income approaches provide a range of reasonable purchase prices for the target compa-
ny. A buyer and seller may each prepare its own analyses based on these valuation approaches. Negotia-
tions typically begin based on the parties’ separate analyses. The final purchase price may come down to
a series of negotiation discussions and may vary from the range determined by the buyer or seller. As
such, the actual deal pricing multiple is usually implied, not explicit.

Measuring Damages: Dollar for Dollar Versus at the Multiple

Indemnity claim damages can be measured two ways: dollar for dollar over a finite period or into perpe-
tuity or at the multiple (if it is determined that a permanent impairment to the value of the business has
occurred).

The basis for damages regarding indemnification claims may relate to specific accounting adjustments
that a buyer believes should have been made to the financial statements of the target prior to the closing
date of the transaction. However, indemnification claims may arise from issues other than accounting is-
sues. These damages are typically based on a multiple of earnings as initially represented versus a mul-
tiple of earnings actually received. In addition, the damages may be based on a dollar-for-dollar recov-
ery basis that depends on whether the misrepresentations temporarily or permanently impaired the target
financial condition.

Claims that result in dollar-for-dollar damage are typically those that have a one-time effect on the target
and that do not impact the target financial condition in future periods (in other words, will not affect fu-
ture cash flows). The practitioner should evaluate each claim in order to determine whether the account-
ing adjustment impacts the buyer’s valuation of the target. An example of this analysis is presented as
follows:

Example: One-Time Inventory Accounting Adjustment Affecting Future Periods

An inventory reserve may have a one-time effect on the balance sheet and a corresponding effect
on the TTM EBITDA. The buyer may have relied on this data in deriving the purchase price. As
such, a one-time adjustment may affect the buyer’s perception of value of the company into fu-
ture periods. Alternatively, this inventory may be an item that is not expected to occur in the fu-
ture and, therefore, would not impact the perception of value.

fn 2 Note that these metrics can all be readily determined from the target’s generally accepted accounting principles-basis financial
statements.

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