[This article was written by Bob Holmen for Fortis Advisors. Additional articles may be found at Fortis News.]
In many private M&A transactions, accounts receivable held by the target company as of the closing date can factor into multiple areas of the transaction, from calculation of the purchase price, to representations and warranties in the merger agreement, to post-closing collection obligations. Issues around accounts receivable are the subject of many post-closing disputes. Accordingly, the parties must negotiate and drafts the definitive agreements with great care around the accounts receivable in order to minimize post-closing disputes.
- Calculation of Merger Consideration
Often, the net value of the accounts receivable is included as a positive adjustment to the merger consideration at closing. The target estimates at closing the value of the accounts receivable, and then post-closing the parties go through a purchase price adjustment process to finalize the closing date balance sheet, including the value of the accounts receivables. Any difference from the value estimated at closing will serve as an adjustment to the final purchase price. Based on data from over 500 M&A deals where Fortis Advisors has served as the post-closing shareholder representative, 64% of such deals include a post-closing adjustment provision (see our Forsite™ M&A Deal Tool.
One important consideration for accounts receivable in purchase price adjustments is whether subsequent events can vary the value of accounts receivable as of the closing. For example, an account that was current as of the closing date may go into default post-closing. Absent any knowledge by the target of the pending default at the time of closing, consider whether the post-closing default should be taken into account on determining the value of the accounts receivables as of the closing. Similarly, if the buyer actually receives payment on an accounts receivable that was in default or otherwise reserved against at closing, consider whether such post-closing payment should be taken into account. Ensuring that the parties agree on the standards for the post-closing adjustment can minimize post-closing disputes.
- Representations and Warranties
A number of representations and warranties in merger agreements potentially cover the value and collectability of accounts receivable. Many merger agreements include direct representations around accounts receivable, including statements as to the value of the accounts receivable (often referring to a schedule of such accounts) and as to the full collectability of such accounts. In addition, a representation that the financial statements “fairly represent” the financial condition of the target company as of the date of such statements, along with a “no material adverse change” since such date, may establish a baseline for the value of the accounts receivable at closing. Also, representations on whether any conditions exist that could give rise to a claim by a third party under a contract could be implicated if a third party contracting party refuses to pay an accounts receivable based on an alleged contract claim.
Parties to the merger agreement should also consider how the representations and warranties coordinate with the purchase price adjustment. Consider whether the buyer should have a “second bite at the apple” on the value of accounts receivable based on the representations and warranties, versus stating that the purchase price adjustment process finally determines the accounts receivable balance, regardless of subsequent collectability of those accounts.
- Collection Guaranties
Some merger agreements include guaranties around the collectability of accounts receivable. If the buyer has not collected all or a specified portion of the accounts receivable by a specified date, the buyer may have recourse to escrowed funds target. If the target agrees to such a provision, often the shareholders demand collection standards, including retention of certain target company personnel (or positions) dedicated to such collection, and a continuation of the target company’s policies and procedures regarding collection of accounts receivable.
In some cases, if the buyer is made whole on uncollected accounts receivable via escrowed funds, shareholders of the target company have the right to receive any subsequently collected amounts, or potentially assume the right to collect on the accounts receivable. However, selling shareholders must be careful about giving collection guaranties, given the buyer has little reason to collect on accounts receivable if it can make itself whole from escrowed funds. Also, buyers must be careful about turning over accounts receivable to the shareholders for collection, given that, without any residual stake in the target company to protect, the shareholders may be incentivized to engage in aggressive collection tactics.