Presenting a live 90-minute webinar with interactive Q&A
M&A Purchase Price Adjustment Clauses
Crafting Provisions to Mitigate Buyers' Financial Risks and Achieve Fair Compensation for Sellers
THURSDAY, MARCH 29, 2012
1pm Eastern
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12pm Central | 11am Mountain
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10am Pacific
Today’s faculty features:
W. Bryan Rakes, Partner, Venable, Baltimore
Michael T. Pedone, Vice President & Deputy General Counsel, Redwood Capital Investments, Baltimore
Matthew Roberson, Senior Vice President, SC&H Capital, Baltimore
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Purchase Price
Adjustment Clauses in M&A
March 29, 2012
W. Bryan Rakes
Venable
Michael T. Pedone
Redwood Capital Investments
Matthew Roberson
SC&H Capital
6
Valuation and Purchase Price
• "Price is what you pay. Value is what you get.“
Warren Buffett
• Valuation is in the eye of the buyer.
• Purchase price is what the seller receives in
consideration for their company.
7
Valuation
• How to buyers determine valuation?
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Intellectual property
Customer access
Contracts
Employees
Competitive advantage
Sustainable cash flow
8
Purchase Price
• Purchase price reflects the tangible statement of valuation that a
buyer sees in a company
• Purchase price can be structured to bridge gaps in valuation
expectations
• Purchase price is consideration paid for a going concern, which
implies that the business will have an appropriate level of working
capital to continue business operations and support future growth.
9
Working Capital
• Working capital is critical to the continued operations of a company
• Buyers want to ensure above adequate levels of working capital
convey with the sale
• Sellers should want to convey an adequate level of working capital,
but no more than necessary
• A purchase price adjustment is often used to assure both buyer and
seller that a mutually agreed upon level of working capital is
delivered at close
10
Working Capital in an LOI
• Working capital is often addressed in the LOI, along with
early language acknowledging the need for a purchase
price adjustment
• Simple Example:
• Purchase Price Adjustment. The Definitive Agreement would provide for an upward or
downward adjustment of the Purchase Price based on a mutually agreed working capital, net
assets or similar target metric for the Business as of the Closing that is based on the
Company’s current assets less current liabilities as historically accounted for by the Company,
excluding any expenses related to the consummation of the transactions contemplated by this
Letter.
11
Working Capital in an LOI
• Consideration to the Sellers will be adjusted on a dollar for dollar basis upward or downward
based upon the comparison of the actual closing working capital of the Company to the
normalized average working capital requirements of the Company over a twelve month
period ("Working Capital Target"), The Company will estimate the Working Capital as of the
closing date ("Estimated Working Capital") and the Consideration to the Sellers will be
adjusted for the difference between the Estimated Working Capital and the Working Capital
Target. Within 90 days of closing, Newco will provide the Sellers the actual closing working
capital balance (the "Closing Working Capital"), subject to a mutually agreed resolution
mechanism.
• There will then be a true-up adjustment based on the difference between the Estimated
Working Capital and the Closing Working Capital, The Target Working Capital, Estimated
Working Capital and Closing Working Capital shall (i) be prepared in accordance with GAAP
and consistent with past practices (to the extent in accordance with GAAP), and (ii) not
include any cash, indebtedness and other fixed obligations, income taxes, accounts receivable
from affiliates (other than those from Company incurred in the ordinary course and on terms
customary for the industry), accounts payable or other sums owing to affiliates (other than
those from Company incurred in the ordinary course and on terms customary for the
industry), Transaction-related expenses of the Company and Sellers, or any excluded assets or
liabilities.
12
Definitions of Working Capital
• “Working Capital” means, as of a given date, the total amount of the Company’s
current assets, less the total amount of the Company’s current liabilities.
• “Working Capital” means the working capital of the Business calculated in
accordance with Exhibit A attached hereto.
13
Definitions Continued…
“Net Working Capital” means the following:
 prepaid expenses and other current assets included in the Purchased
Assets;
 less the sum of:
 the accrued expenses of the Business included in the Assumed
Liabilities; and
 the accrued payroll, taxes, vacation and bonus liabilities (including
commissions), and other current liabilities of the Business included in
the Assumed Liabilities other than deferred revenue;
it being understood that the following shall not be included in the calculation of
“Net Working Capital”: (x) Business Receivables; (y) Business Payables; and (z)
cash and cash equivalents.
14
Definitions Continued…
“Working Capital” means the following, based on a balance sheet of Seller as of a
given date prepared in accordance with GAAP: (a) the net accounts receivable of
Seller as set forth on such balance sheet; (b) plus the accrued fees payable by Buyer to
Seller under Section 5 of the XYZ Agreement as set forth on such balance sheet; and
(c) less the sum of: (i) the accounts payable of Seller as set forth on such balance sheet,
but not including any accounts payable representing amounts payable to independent
contractors of the Business; (ii) the dollar amount of accrued but unpaid vacation time
credited to Transferred Personnel by Buyer pursuant to Section 8.3(f) hereof; (iii) the
accrued commissions payable by Seller under referral agreements as set forth on such
balance sheet; (iv) the $39,600 in setup and on-boarding costs payable by Seller to
Buyer under Section 4 of the XYZ Agreement as set forth on such balance sheet; and
(v) the deferred revenue of Seller as set forth on such balance sheet.
15
Use of a “Collar”
• “Working Capital Lower Target” means Six Hundred Sixty-Five Thousand
Dollars ($665,000).
• “Working Capital Upper Target” means Seven Hundred Forty-Five Thousand
Dollars ($745,000).
If the Final Net Working Capital is:
i.
greater than the applicable Working Capital Upper Target (the amount of such excess, the
“Excess Amount”), Buyer shall pay such Excess Amount to Seller within five (5)
Business Days after the determination of the Final Balance Sheet; or
ii.
less than the applicable Working Capital Lower Target (the amount of such shortfall, the
“Shortfall Amount”), Seller shall pay such Excess Amount to Buyer within five (5)
Business Days after the determination of the Final Balance Sheet.
16
Adjustment Based on Physical Inventory Taken
Immediately Before Closing
Working Capital Adjustment
a. On dates to be selected by Parent (of which Parent shall provide prior notice to
Buyer), which shall be prior to the Closing Date, Parent shall take a physical
inventory of the Seller Inventory. Parent shall permit Buyer to reasonably observe
such physical inventory. Parent shall conduct such physical inventory at a time and
in a manner so as not to unreasonably interfere with the operation of the Business.
b. On or before the thirtieth (30th) day following the Closing Date, Parent shall prepare
and deliver to Buyer a statement, as of 11:59 p.m. on the day before the Closing
Date, which shall reflect the Working Capital (using the value of the Seller
Inventory determined in accordance with Section 3.6(a) above …
17
Definitions of “GAAP” and
“Accounting Principles”
• “GAAP” means United States generally acceptable accounting principles,
consistently applied.
• “GAAP” means United States generally acceptable accounting principles,
consistently applied, as opined upon by XYZ, P.A., independent public
accountants, in connection with the Company’s audit financial statements as of and
for the year ended December 31, 2010.
• “Accounting Principles” means the accounting principles set forth on Exhibit
1.1(a). [Exhibit 1.1(a) broke down the seller’s income statement on a line-by-line
basis, describing the rules that would be used for each one.]
• Note that cash basis accounting is never “GAAP”, per se, so an alternative term
like “Accounting Principles” should be used.
18
Limitation on Types of Disputes
If Buyer determines that there are any inaccuracies in the Closing Balance Sheet
prepared by Seller, Buyer shall deliver to the Seller a written notice setting forth the
alleged inaccuracies in reasonable detail no later than 5:00 p.m. New York, New York
time on the fifteenth (15th) day after receipt of the Closing Balance Sheet from Seller;
provided, however, that the only inaccuracies that may be alleged by Buyer are (a)
claims that Seller failed to apply the Accounting Principles in the preparation of the
Closing Balance Sheet, and (b) mathematical errors.
19
Aged A/R - Exclusion or Partial Adjustment
A. if any Over 180 Account is collected by a Purchaser Entity, in whole or in part,
within sixty (60) days after the Closing Date, Purchaser shall pay to Seller ninetyfive percent (95%) of such collected amount (and Purchaser shall be entitled to
retain the remaining five percent (5%) of such collected amount);
B. to the extent the aggregate amount of 91-180 Accounts collected by the Purchaser
Entities exceeds the amount of 91-180 Accounts that are reserved as uncollectible
for purposes of calculating Net Working Capital, and such excess amounts are
collected within sixty (60) days after the Closing Date, Purchaser shall pay to Seller
ninety-five percent (95%) of such excess collected amounts (and Purchaser shall be
entitled to retain the remaining five percent (5%) of such excess collected
amounts); and
C. as used herein, (1) “Over 180 Account” means any account receivable related to the
Business that was included in the Assets and that was aged over 180 days as of the
Closing Date; and (2) “91-180 Account” means any account receivable related to
the Business that was included in the Assets and that was aged more than 90 days
and less than 181 days as of the Closing Date.
20
Adjustment Based on Multiple of A/R
• If the purchase price is based, in part, on applying a multiple to the value of the
seller’s A/R, any purchase price adjustment needed to include the same multiple.
[Note 6x multiple in 3.9(c)(ii)(B) and (iii)(B) in the following provision.]
• Procedure can include a requirement that the buyer put money in an escrow account
that credit the seller for interest earned on amounts ultimately paid to it.
A/R Deferral; Collection and Remittance of Receivables.
(a) At the Closing, Buyer will retain the A/R Deferral to secure the collection of the
Seller Receivables, and Sellers shall retain control over, and be responsible for, the
collection of the Seller Receivables for one hundred eighty (180) days after the
Effective Date (the “Collection Period”). Buyer will hold the A/R Deferral in a
separate account with Depositary and pay such funds out only in strict accordance with
the terms of this Agreement.
21
(b) No later than the sixty-second (62nd) day after the last day of the Collection Period, Buyer
shall pay to the Seller Agent (for further distribution by the Seller Agent to the Sellers in
accordance with Schedule 4.2(b)(i)) the Final A/R Disbursement Amount, if any, out of the A/R
Deferral (and out of the Buyer’s own funds, if the A/R Deferral is less than the Final A/R
Disbursement Amount).
(c) The “Final A/R Disbursement Amount” shall be calculated as follows:
(i) The following terms relating to the calculation of the Final A/R Disbursement Amount shall
have the following meaning:
(A) “Gross A/R Balance” means the total amount of all Seller Receivables set forth on the A/R
Report, without any reserve or allowance for doubtful accounts.
(B) “Adjusted A/R Balance” means the Gross A/R Balance, less the actual amount of Seller
Receivables listed on the A/R Report that were collected and remitted to Buyer during the
Collection Period.
(C) “Net A/R Balance” means the Adjusted A/R Balance, less Two Hundred Fifty Thousand One
Hundred Thirty-Five Dollars ($250,135).
(D) “Final A/R Deferral Balance” means the A/R Deferral, plus the actual interest paid thereon
by the Depositary from the Closing Date to the date on which Buyer pays the Final A/R
Disbursement Amount, if any, to the Seller Agent.
22
(ii) If the Net A/R Balance is greater than or equal to zero (0), the Final A/R
Disbursement Amount shall be equal to: (A) the Final A/R Deferral Balance; (B) less
the product obtained by multiplying the Net A/R Balance by six (6).
(iii) If the Net A/R Balance is less than zero (0), the Final A/R Disbursement Amount
shall be equal to: (A) the Final A/R Deferral Balance; (B) plus the product obtained by
multiplying the absolute value of the Net A/R Balance by six (6), not to exceed an
amount equal to ten percent (10%) of the A/R Deferral.
23
Adjustments Based on Maximum Amount of
Cash Purchase Price
• If the cash portion of the purchase price is capped, a special purchase price
adjustment my be used to ensure that the total cash consideration does not exceed
such maximum amount.
Notwithstanding the foregoing, in the event the [payment of a positive working capital
adjustment] would cause the amount of cash consideration payable hereunder to exceed
60% of the aggregate consideration payable hereunder, the amount of cash so paid will
be reduced by the amount necessary to cause the amount of cash consideration payable
hereunder to be equal to 60% of the aggregate consideration payable hereunder, and the
Purchaser will issue to the Stockholders’ Agent for further distribution to the Company
Stockholders (pro rata based upon the number of shares of Company Common Stock
held by each on the Closing Date) a number of shares of Series AA Stock equal to the
result obtained by dividing the amount of the reduction in the cash payment made as a
result of the application of this sentence by the Share Value.
24
W. Bryan Rakes
Venable
wbrakes@Venable.com
410.528.2303
Michael T. Pedone
Redwood Capital Investments
410.402.2228
mpedone@redcapinv.com
Matthew Roberson
SC&H Capital
410.403.1500
mroberson@scandh.com