Sometimes mergers and acquisitions don’t meet the expectations of the buyer and/or seller for a variety of reasons. In some cases, forecasted results contain unrealistic synergies or cost savings. In other cases, misrepresentations are made regarding the Company’s historical performance or financial condition at the date of close or sellers don’t receive much contingent consideration because of the buyer’s mismanagement of the Company post-close.

Buyer vs. Seller

Let’s say a seller loses a major contract just before closing and doesn’t disclose the loss to the buyer. The buyer may seek damages based on a revaluation of the Company considering the loss. (This is where a valuation expert is critical.) The buyer’s expert may testify that the contract loss had a material impact on the valuation of the Company and calculate damages based on the decrease in value.

The seller’s expert could counter that the loss of the contract does not negatively impact the valuation of the Company or expected future cash flows. Perhaps customer turnover is to be expected in the Company’s ordinary course of business or maybe the seller was in the process of negotiating new contracts that would have replaced revenues of the lost contract.

In some cases, the Company’s actual performance, post-close, may be relevant. If the Company’s post-closing performance is consistent with the buyer’s expectations at the time the transaction was negotiated, then the seller may argue that the buyer benefited from the deal regardless of the lost contract.

Avoiding Surprises

When privately-held businesses are bought and sold, a portion of the purchase price can be held in an escrow account until certain financial matters are resolved. For example, the purchase agreement may include an earnout where a portion of the purchase price is contingent on certain future financial benchmarks after closing.

Alternatively, a purchase agreement may include a purchase price adjustment clause to reconcile any disparities between the preliminary financial statements and the Company’s actual results. For example, if the Company’s net-working capital increased or decreased between the time of negotiations and closing, the purchase price would be adjusted up or down on a dollar-for-dollar basis.

In many cases M&A financial experts are not consulted with until after the deal closes; however, their expertise can be critical when drafting a purchase price adjustment or earn-out provision. When drafting a purchase agreement, the following should be considered:

  • The definition of “materiality”
  • Relevant accounting practices and standards
  • The definition of net-working capital
  • Specific high-risk accounts
  • Purchase price adjustments and earn-out provisions
  • Who is responsible for preparing closing-date and post-acquisition financial statements

An M&A expert can help evaluate and identify why a deal failed and whether it is related to the wrongdoing of another party. If an M&A financial expert is hired early in the M&A process, such post-acquisition disputes can be avoided.

About the Authors

Jennifer Martin

CPA CFE
Manager, Transaction Advisory Services

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