Monthly Archives: March 2016

Fortis Insight: Purchase Price Adjustment vs. Indemnification Claims [This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

stably In M&A transactions, it is important for sellers that the transaction agreements specify whether certain disputes are purchase price adjustments or indemnification claims.  Without specificity, the buyer may be able to elect the remedy that maximizes recovery for the buyer at the cost of the selling shareholders.

Letchworth Garden City Merger and acquisition agreements often contain clauses calling for a post-closing adjustment in the purchase price based on the difference between an estimated working capital analysis calculated at closing and the actual closing working capital amount calculated post-closing.  In analyzing data from over 500 transactions where Fortis Advisors has served as shareholder representative (summarized in our Forsite™ M&A Deal Tool), 63% of all M&A transactions include post-closing adjustment provisions.

When analyzing actual working capital post-closing, disputes can arise over the proper treatment of certain assets and liabilities under GAAP.  If the parties agree to modify treatment from seller’s past practice, that can result in a working capital adjustment in favor of the buyer.  Typically, that adjustment is dollar-for-dollar, meaning that downward adjustments made to the closing working capital will directly reduce the purchase price for the acquired company.

However, M&A agreements also contain representations and warranties made by the seller as to the accuracy of financial statements delivered to the buyer as part of the diligence process or the closing process.  A dispute over treatment of assets or liabilities under GAAP could also be deemed to breach seller’s representations and warranties on the financial statements.  While resolving the dispute as a “working capital adjustment” rather than a “breach” would seem in the best interests of the selling securityholders, in fact it often is better to handle the matter as a breach.

Often limitations apply to buyer’s ability to recover for a seller’s breach of any representation or warranty under the M&A transaction agreements.  For example, the agreements may include a negotiated “basket” or deductible that must be met before the buyer can recover from the seller.  The agreement also may include a cap on the total amount buyer can recover.

Accordingly, the seller, on behalf of the selling securityholders, should negotiate for language that explicitly limits working capital adjustments to changes in working capital amounts applying the seller’s accounting principles.  Any other claim or dispute regarding the financial statements should be analyzed as an alleged breach of a representation or warranty, and be handled subject to any limitations on buyer’s ability to recover.

Fortis Insight: Monitoring the Earn-Out

[This insight was written by Bob Holmen for Fortis Advisors.  Additional insights may be found at Fortis Insights]

When negotiating an M&A transaction, often the buyer and seller bridge the gap in negotiations over the acquisition price by establishing an earn-out to enable the seller to reap greater rewards if as the seller’s products and services grow under the buyer’s new ownership.  However, after closing, it can be very challenging for the seller to gain insight into the acquired business and asset progress toward achievement of earn-out objectives and milestones.  To address this, sellers are increasingly negotiating post-closing information rights.

We have analyzed data from over 500 transactions where Fortis Advisors has served as shareholder representative, as captured in our Forsite™ M&A Deal Tool.  While 80% of all deals with earn-outs include some form of information rights for the seller, generally those rights are limited to annual written statements—only 26% of deals require more frequent reports, and 30% of deals provide for in-person meetings to review progress toward achievement of contingent payments.

In order to enable the selling securityholders to monitor and, where possible, maximize return on earn-outs, the seller should negotiate rights for the shareholder representative to (1) receive meaningful periodic (ideally no less than bi-annual) reports of progress toward achievement of contingent payment, and (2) if possible, require periodic in-person meetings to discuss the progress.  Finally, the shareholder representative should have rights to review buyer records reasonably sufficient to calculate the metrics upon which the contingent payment is based.