Post-closing adjustments are typically included in the transaction documents of any M&A transaction when there is a period of time between the determination of purchase price consideration and the closing of the acquisition, usually substantial enough to have a bearing on the value of the target determined as of the signing date. The rationale for using post-closing adjustments is to bridge the gap between the value of the target as determined at the time of signing of the transaction documents and at the time of close of the transaction and to allocate the risks of business operations during this period between the purchaser and the seller. A well negotiated post-closing mechanism will allay the concerns of the seller (in relation to the agreed consideration) and the purchaser (in relation to leakage of the value of the target) and increase the certainty of closure of the transaction.
The adjustments in relation to purchase price may be based either on balance sheet accounts or on the basis of performance of the business of the target. Usually a reference balance sheet is prepared at the signing stage and a preliminary purchase price is set forth in the transaction documents, together with appropriate price adjustment clauses. The initial purchase price is adjusted post the determination of the closing accounts (and hence the determination of the final consideration), to account for the changes between the reference accounts and the closing accounts with respect to the chosen balance sheet items. In such a case, the risks in relation to the items not covered by the price adjustments are assumed by the purchaser. A few price adjustment mechanisms that are typically employed by the parties in M&A transactions are enumerated herein.
The parties may agree to revise the purchase price to account for changes in the net working capital between the time of estimate and the time of close. In such cases, protracted discussions may ensue between the par ties in relation to the definition of net working capital. The purchaser would assume the risk in relation to the items not included in the definition of net working capital. In the absence of such adjustment mechanism, the seller might be able to influence the purchase price by adopting certain methods including putting off the payments to be made by the target in respect of inventory/ other items, urging the debtors to repay earlier than the due / expected date etc.
The seller and the purchaser may also agree to compute the final purchase price based on the preliminary purchaser price with the deduction of debt (as of the clos1ng date). In such cases, parties typically negotiate on the items to be included within the scope of the 'debt' lo be deducted from the preliminary purchase price. The purchaser is not protected from risks in relation to the items nor included within the scope of the definition of 'debt'.
The adjustment provisions may also contain upper and / or lower limits for the adjustment amounts (a clause capping the adjustment amounts) or may contain clauses providing that the adjustment may not happen unless an upper or lower benchmark is exceeded (i.e. A de minimis clause).
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