1 Presenting a live 90-minute webinar with interactive Q&A M&A Purchase Price Adjustment Clauses Crafting Provisions to Mitigate Buyers' Financial Risks and Achieve Fair Compensation for Sellers THURSDAY, MARCH 29, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: W. Bryan Rakes, Partner, Venable, Baltimore Michael T. Pedone, Vice President & Deputy General Counsel, Redwood Capital Investments, Baltimore Matthew Roberson, Senior Vice President, SC&H Capital, Baltimore The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.
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5 Purchase Price Adjustment Clauses in M&A March 29, 2012 W. Bryan Rakes Venable Michael T. Pedone Redwood Capital Investments Matthew Roberson SC&H Capital
6 6 Valuation and Purchase Price "Price is what you pay. Value is what you get. Warren Buffett Valuation is in the eye of the buyer. Purchase price is what the seller receives in consideration for their company.
7 7 Valuation How to buyers determine valuation? Intellectual property Customer access Contracts Employees Competitive advantage Sustainable cash flow
8 8 Purchase Price Purchase price reflects the tangible statement of valuation that a buyer sees in a company Purchase price can be structured to bridge gaps in valuation expectations Purchase price is consideration paid for a going concern, which implies that the business will have an appropriate level of working capital to continue business operations and support future growth.
9 9 Working Capital Working capital is critical to the continued operations of a company Buyers want to ensure above adequate levels of working capital convey with the sale Sellers should want to convey an adequate level of working capital, but no more than necessary A purchase price adjustment is often used to assure both buyer and seller that a mutually agreed upon level of working capital is delivered at close
10 10 Working Capital in an LOI Working capital is often addressed in the LOI, along with early language acknowledging the need for a purchase price adjustment Simple Example: Purchase Price Adjustment. The Definitive Agreement would provide for an upward or downward adjustment of the Purchase Price based on a mutually agreed working capital, net assets or similar target metric for the Business as of the Closing that is based on the Company s current assets less current liabilities as historically accounted for by the Company, excluding any expenses related to the consummation of the transactions contemplated by this Letter.
11 11 Working Capital in an LOI Consideration to the Sellers will be adjusted on a dollar for dollar basis upward or downward based upon the comparison of the actual closing working capital of the Company to the normalized average working capital requirements of the Company over a twelve month period ("Working Capital Target"), The Company will estimate the Working Capital as of the closing date ("Estimated Working Capital") and the Consideration to the Sellers will be adjusted for the difference between the Estimated Working Capital and the Working Capital Target. Within 90 days of closing, Newco will provide the Sellers the actual closing working capital balance (the "Closing Working Capital"), subject to a mutually agreed resolution mechanism. There will then be a true-up adjustment based on the difference between the Estimated Working Capital and the Closing Working Capital, The Target Working Capital, Estimated Working Capital and Closing Working Capital shall (i) be prepared in accordance with GAAP and consistent with past practices (to the extent in accordance with GAAP), and (ii) not include any cash, indebtedness and other fixed obligations, income taxes, accounts receivable from affiliates (other than those from Company incurred in the ordinary course and on terms customary for the industry), accounts payable or other sums owing to affiliates (other than those from Company incurred in the ordinary course and on terms customary for the industry), Transaction-related expenses of the Company and Sellers, or any excluded assets or liabilities.
12 12 Definitions of Working Capital Working Capital means, as of a given date, the total amount of the Company s current assets, less the total amount of the Company s current liabilities. Working Capital means the working capital of the Business calculated in accordance with Exhibit A attached hereto.
13 13 Definitions Continued Net Working Capital means the following: prepaid expenses and other current assets included in the Purchased Assets; less the sum of: the accrued expenses of the Business included in the Assumed Liabilities; and the accrued payroll, taxes, vacation and bonus liabilities (including commissions), and other current liabilities of the Business included in the Assumed Liabilities other than deferred revenue; it being understood that the following shall not be included in the calculation of Net Working Capital : (x) Business Receivables; (y) Business Payables; and (z) cash and cash equivalents.
14 14 Definitions Continued Working Capital means the following, based on a balance sheet of Seller as of a given date prepared in accordance with GAAP: (a) the net accounts receivable of Seller as set forth on such balance sheet; (b) plus the accrued fees payable by Buyer to Seller under Section 5 of the XYZ Agreement as set forth on such balance sheet; and (c) less the sum of: (i) the accounts payable of Seller as set forth on such balance sheet, but not including any accounts payable representing amounts payable to independent contractors of the Business; (ii) the dollar amount of accrued but unpaid vacation time credited to Transferred Personnel by Buyer pursuant to Section 8.3(f) hereof; (iii) the accrued commissions payable by Seller under referral agreements as set forth on such balance sheet; (iv) the $39,600 in setup and on-boarding costs payable by Seller to Buyer under Section 4 of the XYZ Agreement as set forth on such balance sheet; and (v) the deferred revenue of Seller as set forth on such balance sheet.
15 15 Use of a Collar Working Capital Lower Target means Six Hundred Sixty-Five Thousand Dollars ($665,000). Working Capital Upper Target means Seven Hundred Forty-Five Thousand Dollars ($745,000). If the Final Net Working Capital is: i. greater than the applicable Working Capital Upper Target (the amount of such excess, the Excess Amount ), Buyer shall pay such Excess Amount to Seller within five (5) Business Days after the determination of the Final Balance Sheet; or ii. less than the applicable Working Capital Lower Target (the amount of such shortfall, the Shortfall Amount ), Seller shall pay such Excess Amount to Buyer within five (5) Business Days after the determination of the Final Balance Sheet.
16 16 Adjustment Based on Physical Inventory Taken Immediately Before Closing Working Capital Adjustment a. On dates to be selected by Parent (of which Parent shall provide prior notice to Buyer), which shall be prior to the Closing Date, Parent shall take a physical inventory of the Seller Inventory. Parent shall permit Buyer to reasonably observe such physical inventory. Parent shall conduct such physical inventory at a time and in a manner so as not to unreasonably interfere with the operation of the Business. b. On or before the thirtieth (30 th ) day following the Closing Date, Parent shall prepare and deliver to Buyer a statement, as of 11:59 p.m. on the day before the Closing Date, which shall reflect the Working Capital (using the value of the Seller Inventory determined in accordance with Section 3.6(a) above
17 17 Definitions of GAAP and Accounting Principles GAAP means United States generally acceptable accounting principles, consistently applied. GAAP means United States generally acceptable accounting principles, consistently applied, as opined upon by XYZ, P.A., independent public accountants, in connection with the Company s audit financial statements as of and for the year ended December 31, Accounting Principles means the accounting principles set forth on Exhibit 1.1(a). [Exhibit 1.1(a) broke down the seller s income statement on a line-by-line basis, describing the rules that would be used for each one.] Note that cash basis accounting is never GAAP, per se, so an alternative term like Accounting Principles should be used.
18 18 Limitation on Types of Disputes If Buyer determines that there are any inaccuracies in the Closing Balance Sheet prepared by Seller, Buyer shall deliver to the Seller a written notice setting forth the alleged inaccuracies in reasonable detail no later than 5:00 p.m. New York, New York time on the fifteenth (15 th ) day after receipt of the Closing Balance Sheet from Seller; provided, however, that the only inaccuracies that may be alleged by Buyer are (a) claims that Seller failed to apply the Accounting Principles in the preparation of the Closing Balance Sheet, and (b) mathematical errors.
19 19 Aged A/R - Exclusion or Partial Adjustment A. if any Over 180 Account is collected by a Purchaser Entity, in whole or in part, within sixty (60) days after the Closing Date, Purchaser shall pay to Seller ninetyfive percent (95%) of such collected amount (and Purchaser shall be entitled to retain the remaining five percent (5%) of such collected amount); B. to the extent the aggregate amount of Accounts collected by the Purchaser Entities exceeds the amount of Accounts that are reserved as uncollectible for purposes of calculating Net Working Capital, and such excess amounts are collected within sixty (60) days after the Closing Date, Purchaser shall pay to Seller ninety-five percent (95%) of such excess collected amounts (and Purchaser shall be entitled to retain the remaining five percent (5%) of such excess collected amounts); and C. as used herein, (1) Over 180 Account means any account receivable related to the Business that was included in the Assets and that was aged over 180 days as of the Closing Date; and (2) Account means any account receivable related to the Business that was included in the Assets and that was aged more than 90 days and less than 181 days as of the Closing Date.
20 20 Adjustment Based on Multiple of A/R If the purchase price is based, in part, on applying a multiple to the value of the seller s A/R, any purchase price adjustment needed to include the same multiple. [Note 6x multiple in 3.9(c)(ii)(B) and (iii)(b) in the following provision.] Procedure can include a requirement that the buyer put money in an escrow account that credit the seller for interest earned on amounts ultimately paid to it. A/R Deferral; Collection and Remittance of Receivables. (a) At the Closing, Buyer will retain the A/R Deferral to secure the collection of the Seller Receivables, and Sellers shall retain control over, and be responsible for, the collection of the Seller Receivables for one hundred eighty (180) days after the Effective Date (the Collection Period ). Buyer will hold the A/R Deferral in a separate account with Depositary and pay such funds out only in strict accordance with the terms of this Agreement.
21 21 (b) No later than the sixty-second (62nd) day after the last day of the Collection Period, Buyer shall pay to the Seller Agent (for further distribution by the Seller Agent to the Sellers in accordance with Schedule 4.2(b)(i)) the Final A/R Disbursement Amount, if any, out of the A/R Deferral (and out of the Buyer s own funds, if the A/R Deferral is less than the Final A/R Disbursement Amount). (c) The Final A/R Disbursement Amount shall be calculated as follows: (i) The following terms relating to the calculation of the Final A/R Disbursement Amount shall have the following meaning: (A) Gross A/R Balance means the total amount of all Seller Receivables set forth on the A/R Report, without any reserve or allowance for doubtful accounts. (B) Adjusted A/R Balance means the Gross A/R Balance, less the actual amount of Seller Receivables listed on the A/R Report that were collected and remitted to Buyer during the Collection Period. (C) Net A/R Balance means the Adjusted A/R Balance, less Two Hundred Fifty Thousand One Hundred Thirty-Five Dollars ($250,135). (D) Final A/R Deferral Balance means the A/R Deferral, plus the actual interest paid thereon by the Depositary from the Closing Date to the date on which Buyer pays the Final A/R Disbursement Amount, if any, to the Seller Agent.
22 22 (ii) If the Net A/R Balance is greater than or equal to zero (0), the Final A/R Disbursement Amount shall be equal to: (A) the Final A/R Deferral Balance; (B) less the product obtained by multiplying the Net A/R Balance by six (6). (iii) If the Net A/R Balance is less than zero (0), the Final A/R Disbursement Amount shall be equal to: (A) the Final A/R Deferral Balance; (B) plus the product obtained by multiplying the absolute value of the Net A/R Balance by six (6), not to exceed an amount equal to ten percent (10%) of the A/R Deferral.
23 23 Adjustments Based on Maximum Amount of Cash Purchase Price If the cash portion of the purchase price is capped, a special purchase price adjustment my be used to ensure that the total cash consideration does not exceed such maximum amount. Notwithstanding the foregoing, in the event the [payment of a positive working capital adjustment] would cause the amount of cash consideration payable hereunder to exceed 60% of the aggregate consideration payable hereunder, the amount of cash so paid will be reduced by the amount necessary to cause the amount of cash consideration payable hereunder to be equal to 60% of the aggregate consideration payable hereunder, and the Purchaser will issue to the Stockholders Agent for further distribution to the Company Stockholders (pro rata based upon the number of shares of Company Common Stock held by each on the Closing Date) a number of shares of Series AA Stock equal to the result obtained by dividing the amount of the reduction in the cash payment made as a result of the application of this sentence by the Share Value.
24 24 W. Bryan Rakes Venable Michael T. Pedone Redwood Capital Investments Matthew Roberson SC&H Capital