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SPA Purchase Price Calculation and Adjustments

 Introduction

 Overview
– Purchase price adjustment tools
– Locked box
– Earn out
 Cash free / debt free ("net debt")
 Working capital
 Rationale
 Calculation of value of shares sold ("equity
value") based on enterprise value (often DCF
method)

 Protection that target has certain value at closing

 Time lag between signing and closing – protection

against manipulation by the seller
 Rationale
 Even if signing = closing:

– likely no current financial statements available

– purchase price calculation thus often based on

last/"historical" (audited) financial statements
 Rationale
 Allocation of economic risk and profit of current
operations

 PPA aim at reflecting changes in certain values of

the target

 PP adjustment or calculation is not a substitute

for a MAC clause
 Basic Scenarios
 Adjustment ≠ calculation

 Purchase Price calculation: based on

formula/parameter (but no fixed amount), e.g.:
– EBITDA
– EBIT
– revenue | turnover
– (net) income
 Basic Scenarios
 Purchase price adjustment: based on agreed
"initial" price (typically the enterprise value),
which is subsequently adjusted, e.g.

– cash free/debt free ("net debt")

– working capital

– net assets (equity guarantee)

 Timing | Relevant Date
 Purchaser prefers adjustment as of Closing Date
– business until closing taken into account
– control over preparation of closing accounts
 Seller prefers Effective Date prior to Closing
– certainty over PP as early as possible
– control over "effective date" accounts
– possibly: interest on PP from effective date
 Valuation Rules
 Determination of accounting rules
– agree on valuation methods, e.g. inventory
valuation, depreciation of overdue accounts
receivable
– "balance sheet continuity"
– exercise of discretionary valuation rules under
(local) GAAP
 Closing Accounts Process
 Process rules
– deadline for preparation & delivery to the
other side (audit?)
– time for review & objections, format of
objections (access to target company)
– dispute resolution process, including
selection and appointment of expert, costs
 Cash Free | Debt Free

"The purchase price for the Share (the "Purchase

Price") shall be USD [●] (the "Base Amount")
plus Cash minus Debt, if any, in each case as at
the Closing Date, plus or minus, as the case may
be, the Working Capital Deviation, if any."
 Definitions of Cash & Debt
 Definitions of adjustment items are critical
 Use designations from most recent accounts
 Use "account codes" from target's accounting
 Cash – items often discussed
– cash equivalents (e.g. cheques)
– liquid assets (e.g. securities)
– "trapped cash" (e.g. cash in subsidiaries)
 Definitions of Cash & Debt
 Debt (financial debt) – items often discussed
– accruals/provisions
– pension liabilities
– deferred payments
– contingent liabilities (e.g. guarantees issued)
 Repayment of inter-group debt (e.g. shareholder
loans)
 Working Capital Adjustment
 W/C = inventory + accounts receivable –
accounts payable (all not part of "cash" or "debt")
 Goal: avoid manipulation w cash/debt impact
 Examples:
– sale of inventory at discount prices
– aggressive collection of accounts receivable
– non-payment of accounts payable
 Working Capital Adjustment
 Determine W/C base amount on the basis of:
– latest available annual accounts
– (annual) average | forecast
 Fixed amount or corridor
 Beware of fluctuations (seasonality)
 Adjustment upwards/downwards or both ways;
de minimis?
 Other Manipulation Risks
 Disposal of fixed assets
 Change in investments, capital expenditure
 How to avoid
– "ordinary course" covenants
– additional adjustment items, e.g. fixed assets
and/or CAPEX based adjustments
 Locked Box
 PP is fixed based on historical accounts
 No adjustment mechanism
 Typically in seller interest
– certainty as to PP even before signing
– no cumbersome closing accounts review
process and potential disputes
 Locked Box
 Purchaser risks
– impact of ongoing trading will not be reflected
in PP
– risk of "leakage"
– very detailed "ordinary course" covenants
required – monitoring difficult
– MAC clause required
 Earn Out

 Portion of the purchase price is conditional upon

target reaching certain milestones during a
specific period after closing.

 Benchmarks are typically financial (e.g. revenues,

net income, cash flow, earnings per share, EBIT,
EBITDA), sometimes also non-financial
(e.g. development of core product)
 Earn Out
 Mostly used in private targets
 Often used if buyer and seller disagree on value
of target
 Earn-out arrangements reward seller if its
projections are accurate, while protecting the
buyer from overpaying if they are not.
 Risks:
– Purchaser may be hindered to reorient target
– Late disputes about contingent payment
 Earn Out
 Seller: revenue based; Buyer: net income based;
mostly used earnings-based figures (e.g.
EBIT/EBITDA)
 Formula for calculating the payment amount
 Length of earn-out period: typically 2-5 years
 Determination of satisfaction of threshold
– Determination of earn-out
– Accounting issues
– Operation of acquired business during earn-
out period
Thank You!