Keeping the price right – avoiding the post – deal pitfalls
Even with the best advisors, buying or selling a business can be a fraught experience for all involved as completion day looms. With a seemingly endless list of last minute issues to deal with, there is one fundamental area that experience suggests can be overlooked as the pressure mounts to get the deal over the line – and that is the thorny issue of the post-completion price adjustment mechanism, either in the form of completion accounts or an earn-out.
What are completion accounts and earn outs?
A buyer will usually look to remove any element of risk involved in the transaction by making at least some of the consideration contingent on achieving an agreed target for either net assets at completion (as shown in a set of completion accounts) or profits achieved over an agreed period after completion (an earn out). If net assets or profits are higher than the target, then this can result in additional payments to the seller. The ‘rules’ for the calculation of either a completion account balance sheet or a profit and loss account for an earn out must be set out in the Share Purchase Agreement (“SPA”); having the properly considered clauses in this document will reduce the risk of dispute and a loss of value after the deal has completed.
What are the potential pitfalls?
Think carefully about who is best placed to prepare the accounts, and conversely which party is better to reserve its rights to review and challenge. Sellers often think they have to prepare to maintain control. However, if the accounts department is now employed by the buyer, how can they get reliable information to enable them to do that? The accounting rules to be applied also need careful consideration. Woolly drafting around ‘consistent with previous accounting policies’ or ‘generally accepted accounting policies’ (“GAAP”) are a potential cause of uncertainty and dispute. Parties need to be clear about whether consistency or GAAP should apply if a previous accounting policy is shown to be non-GAAP compliant. Parties also need to be clear about what consistency means – does it mean the application of the same high level accounting policies, or the same detailed approach to the interpretation of the high level policy? When disputes do arise, they are often referred to an independent accountant to act as ‘expert determiner’. This can be a protracted process, unless the parties agree a realistic process and timetable for the appointment of an expert and the provision of submissions and information. Sellers should consider in particular a cut-off period on the use of hindsight that can be used to support arguments and adjustments proposed by the buyer. Otherwise, events occurring months, or even years, after the completion date could be used by the buyer to change the price.