In any economic cycle, most M&A transactions in the US involve some form of a post-closing price adjustment. With dealmakers navigating increased economic uncertainty, buyers and sellers are at even greater risk of a disconnect in pricing positions and interpretations of deal terms. Failing to prepare for those negotiations and potential disputes could result in substantial loss of deal value.
Post-closing disputes can be lengthy, expensive and distracting, and they inevitably create uncertainty over the final purchase price. Whether you’ve recently completed a deal or are in the middle of a challenging post-closing price negotiation, you have options to protect and even enhance your deal value. The closing statement and the counterparty’s dispute notice are each side’s only chance to put their pricing position on the table, so they should do so thoughtfully.
Before examining options, let’s look at the components of price adjustments in a closing accounts pricing mechanism and how the process ultimately affects purchase price. A typical closing statement sets out the balances required to calculate the final purchase price — usually some combination of cash, indebtedness, working capital and seller transaction expenses.
Unless otherwise commercially agreed to, the closing statement has a dollar-for-dollar impact on the purchase price, and buyers and sellers must dedicate time and effort to prepare and review this pricing statement or risk leaving significant value on the table.
After legal closing, a purchase price true-up occurs calculated as the difference between (1) the estimated closing statement (i.e. estimated cash, indebtedness, working capital and seller transaction expenses), which is prepared by the seller prior to closing, and (2) the final closing statement (and each component thereof), which is measured as of the closing date but typically prepared by the buyer 60 to 90 days after closing.
Potential issues surrounding post-closing price adjustments are exacerbated during times of uncertainty, including the unprecedented COVID-19 pandemic. So preparation and strategy become even more crucial.
The practical requirements of the closing statement process, such as meeting the submission deadline and having the right resources, can be as important as the commercial and contractual considerations relating to agreement interpretation and application of judgment. They present logistical challenges that, if not addressed, can erode deal value.
For an optimal outcome, a dedicated decision-maker with a broad understanding of the commercial negotiations that took place pre-signing should oversee the post-closing price adjustment process. Parties are now navigating difficulties of working virtually in addition to existing deal complexities, while still having to meet the condensed time frames established in the sale and purchase agreement. This makes it even more critical to have focus and accountability in the process.
For the preparer, once the position is set in the draft closing statement, dealmakers will not have another opportunity to make (favorable) adjustments. The preparation time is the only time you have to solidify your position to extract or protect value.
For the reviewer, the dispute notice must have all known areas of disagreement included, as common practice nearly always includes clauses prohibiting introduction of new deal issues.
Case in point #1: The consequences of not being prepared
However, the contractual resolution process did not allow for the introduction of new items at this stage. Therefore, the buyer couldn’t avail themselves of the favorable adjustments identified during the late mid-month closing process and couldn’t use the $5 million in deal value to offset the unfavorable adjustments proposed by the seller.
Regardless of your role in a transaction, knowing all possible pricing levers in an agreement will help you develop a holistic position and negotiate the best value for you and your stakeholders. Those levers include the closing statement, representations and warranties, indemnities, side arrangements, intercompany settlements and terms of transition service agreements (TSAs).
The post-closing price adjustment process is one of the final steps in a deal. Although there is a prescribed timeline in the agreement, parties sometimes engage in prolonged discussions well after the closing date. Strategically laying the groundwork for the twists and turns of the negotiations to a final purchase price will help avoid giving away value too early in the process.
Business pressure caused by the economic recession and changing political and regulatory environment will likely impact both the negotiation strategy and the timeline. Though you may not be able to predict everything that could happen, modeling potential scenarios and outcomes will allow you to be more effective during these negotiations.
Case in point #2: Being strategic from the onset will benefit future negotiations
The strategy put in place before producing the closing statement allowed the seller to negotiate more leniently on the amounts proposed by the buyer without leaking value, which quickly resolved the negotiations.
The issues that were most contentious during the pre-signing process will likely become equally contentious – and subject to dispute – after closing. This is likely to be magnified in times of uncertainty, such as during the COVID-19 pandemic. Prepare yourself with the best arguments that support your preferred pricing position and with rebuttals for positions that may be presented by the other side.
As a seller, it helps to gather relevant historical accounting information and records before closing. After that point, the books and records will likely be controlled by the buyer, and access, even if contractually allowed, will inevitably be limited and possibly restricted.
As a buyer coming to grips with a newly acquired business, ensuring you have full access to all the target company’s historical information and relevant facts will better guide the formulation of the closing statement.
In challenging economic times, it is more likely that a buyer may try to take aggressive positions in the closing accounts. For example, a buyer may attempt to record more conservative inventory reserves at closing if there is a precipitous drop in sales post-closing. This makes it even more critical that sellers focus on access to historical records before transferring the business to ensure they can demonstrate consistency with the contractually required accounting policies.
Having an initial kickoff or strategy meeting to discuss known issues before the post-closing preparation or review clock starts ticking helps make sure all teams – finance, accounting, legal, tax and external advisers – are aligned, as time will be of the essence.
It helps to remember that disputes often relate to areas of accounting judgment around accruals, reserves, provisions and the point of recognition of a particular asset or liability.
Case in point #3: The same pressure points persist
The parties ended up in a prolonged resolution process arguing GAAP versus consistency.
Typically the post-closing price adjustment process is intended to be a fair and equitable way to true-up the estimated purchase price based on the actual closing balance sheet, which cannot be determined until after legal closing. In the flurry of activity leading up to closing, which can be magnified in periods of uncertainty, the pre-closing estimates process can sometimes be overlooked, creating a number of problems. Consider the following:
It is therefore important to understand the incentives of each party and the unique deal dynamics when preparing or reviewing the estimated purchase price. In all situations, timing is important – both to prepare the good-faith estimates and to have ample time to review the estimates (and provide comments or adjustments, if needed).
Case in point #4: No post-closing recovery, no buyer’s remorse
However, the buyer’s closing statement was limited to $10 million for any additional downward adjustments to the purchase price, and it missed out on approximately $20 million of value. The buyer’s closing statement position, as limited to the contract, was then subject to dispute by the seller, and good faith negotiations led to further erosion of deal value.