Purchase Price Adjustments...It Ain't Over Until It's Over    

As often happens in negotiation of business buy/sell transactions, there are often many hurdles beyond just the negotiation of price and terms. Buyers and Sellers often believe the work is almost done once a Letter of Intent is signed.  Certainly, by the time due diligence is completed the path to closing is all down hill.  Or is it?  Given the increasing frequency of post-closing purchase price adjustments, often times the heavy negotiation begins when these final points are discussed.

Purchase price adjustments, such as working capital adjustments, earn-outs and indemnification provisions, are used frequently in business transactions as tools to mitigate financial risks to buyers while ensuring fair compensation to sellers. In recent years, purchase price adjustments have become routine in business transactions as economic uncertainty has decreased the reliability of traditional valuation metrics, such as historical financials and performance measures. While these tools are useful to bridge purchase price gaps and address certain "unknowns" of a business, careful drafting and thoughtful analysis must be part of any purchase price adjustment mechanism.

A Working Capital Adjustment, which is typically used to compensate or penalize a seller for an increase or decrease in the estimated working capital at closing, is the most common form of post-closing purchase price adjustment. In its simplest form, the seller estimates its working capital (typically, current liabilities minus current assets) prior to closing, and the buyer conducts a "true-up" audit of those numbers after the closing.  However, there is no "one size fits all" working capital adjustment calculation. Each formula should take into consideration the specifics of the business.  For some transactions, working capital may not even be the best measure for adjustment.  The parties should consider whether: (1) the buyer's or seller's historical accounting treatment should be used to determine working capital; (2) there should be specific inclusions and exclusions from working capital; (3) there are conflicts with indemnification provisions, i.e., avoiding a "double dip"; and (4) working capital adjustment examples should be included as an exhibit to the purchase agreement.  Both parties should understand precisely what the adjustment intends to achieve and how the provision will operate in practice.  

An Earn-Out provision is another form of purchase price adjustment that conditions a portion of the purchase price upon the company's achievement of specified operational or financial milestones. These provisions are often used to: (1) bridge purchase price gaps, (2) incentivize the company's post-closing operational performance, and/or (3) align the strategic goals of the company with its financial performance. Because these provisions are the source of many post-closing disputes, it's important to put in the effort up front to define the rules.  Simple metrics are best that leave little room for ambiguity. As a seller, you should insist on metrics that are within your control. For example, you should never agree to an operations-based earn-out if you are not going to have any operational oversight or control post-close. For a seller, consider covenants regarding future operations of the company to maximize earn-out potential. A buyer will want to limit those same types of covenants to the extent they interfere with the buyer's ability to conduct its business.  Defining with specificity the up-front expectations regarding performance goals is also an integral part of putting together an earn-out package. Most earn-outs are based on post-closing net revenues or EBITDA. Simple and clear earn-out objectives will eliminate many post-closing disputes relating to earn-outs.

Indemnity Claims are used primarily for breaches of representations and warranties by the seller(s) or for third party claims brought against the buyer relating to the seller's past operations. While indemnity claims are relatively infrequent, the current economic climate has stimulated an increase in such claims.  It is impossible to prevent any chance of indemnification claims.  First and foremost, sellers can limit their risk by: (1)  Limiting the duration of any survival period for representations and indemnity obligations; (2) Limiting the dollar amount of total indemnity obligations, and creating an escrow account or deductibles for de minimus claim amounts; (3) Avoiding joint and several liability among several sellers; and (4) Requiring a buyer to represent that it is not aware of existing issues that could give rise to a claim.

After the deal closes, the parties should focus on transition and/or integration issues rather than worrying to much about potential or actual post-closing disputes. Remember that the personal relationship between buyer and seller, and their ability to work together and trust each other, is probably more important to the success of a transaction than any of the provisions in the agreement!  

For more information contact Touchstone!

Touchstone Business Listings: 

Well-Known Independent Men's & Women's Contemporary Clothing Store
- Gross $2,600,000, Purchaser to Submit Offer/Terms
- Strong History of Profits, Real Estate may be Purchased/Leased  

Independently owned retail store specializing in contemporary men's and women's clothing and shoes. In business for almost 40 years, the award-winning business is known for exceptional service and broad and unique clothing selections in categories ranging from suits and dresses to denim and t-shirts. This business has provided steady income for the owners through all types of economic cycles. The Sellers own the real estate with may be purchased or leased. This is an exceptional opportunity to own one of the metro area's premier retail stores, with opportunity to expand geographically and online.

This is a tax practice for sale in Douglas County with annual revenues of approximately $410,000. This quality practice has a well-established client base that includes corporations, partnerships, trusts, nonprofits and individual tax clients. Revenues are composed of approximately 70% tax preparation, with the tax revenues split almost evenly between businesses and individuals. Other services include annual write-up, bookkeeping and compilations. The year round revenues yield good cash flow to owner. This turn-key practice would be a great size for an addition as a satellite office or an individual buyer looking to jump into practice ownership. The client base should lend itself to further expansion of services and growth through referrals.

This Denver CPA practice for sale on the south side of town has annual gross revenues of just over 200,000. It is a well- established practice provides individual and business accounting, auditing and bookkeeping services. Revenues include (8%) from bookkeeping, payroll, and accounting services, (27%) from audit, review & compilation, and (65%) from tax return preparation for individuals. business clients, and trusts. With a solid fee structure and strong cash flow to owner of 80% of gross every year, this turnkey practice would be the perfect size and opportunity for an individual looking to transition into practice ownership.

Operating for over 10 years, this business is well-known among Grand Lake and mountain area homeowners, many of which have vacation homes, which tend to have higher turnover rates.  That creates steady demand for remodel, interior design and home decor products.  Customers choose this business for its mountain style furnishings and convenient location -- and the individual attention the store owner can offer. The business has strong relationships with suppliers and many great reference customers.    The business is being offered with the real estate, a 1,080 sf condo on the boardwalk in downtown Grand Lake, CO. The owner would consider leasing the real estate as well.  This is a great opportunity for an individual interior designer or Metro area firm to gain a footprint in the mountain market.

Colorado Springs CPA Practice

The company is a globally recognized custom digital electronics and control / systems integrator firm specializing in high- performance commercial board rooms, media projection systems, media rooms, lighting/climate control, communications, security, environmental/energy management, pre-wire and automation control systems for both residential and commercial applications. With a 23-year history, in addition to its stability/longevity, the company's strengths are its extensive scope of services, highly trained/certified staff, extensive customer base, impressive design studio and reputation as a leading design/integrator. 

This company was founded with the mission to assist financial institutions develop a sustainable competitive advantage through service quality delivery and sales effectiveness. The firm specializes in research, training and consulting solutions that improve bottom-line sales and service quality results. The firm's products include a proven and proprietary process for inculcating cultural change, service quality research via customer interviews, on-site mystery shopping and web-based surveys, a comprehensive library of basic and advanced sales, service and leadership training programs, training needs assessment process, leadership skills inventory and incentive compensation consulting. Founded in 1995, the firm has a 15 year track record of producing results for financial institutions throughout North America. 

 Local Metal Fabrication Die Casting Manufacturer 

The company is a Denver-based die caster, who manufactures zinc and aluminum components. Castings are small (less than 2 lbs.) and are typically produced in short run quantities of less than 1,000 per order. Customers are primarily local. In over 60 years of existence, the Company has built a strong local reputation for quality service. The Company operates from a wholly-owned production and warehouse facility which is available in addition to the purchase price. This is an opportunity for a synergistic acquirer to add additional capabilities; a strategic combination with a firm already in the die casting or a related machine shop industry; or, an individual to acquire a small family-run business with a 63+ year operating history.

Established neighborhood restaurant/bar located in renovated historic building in NE metro Denver area. Cozy layout with seating for 60 +/-, open for dinner only, catering service that may be expanded. Excellent food, award-winning recognition, full liquor license in place. Opened in 1997, current concept of fine dining with a family atmosphere is a successful stand alone model or could potentially be replicated in multiple locations. Loyal customer base is comprised of urban professionals and families from the greater Denver metro area and from surrounding suburbs. Low rent, clean books, sales have held-up well through this economic cycle. Perfect opportunity for young or established Chef with energy to take over a successful restaurant and add their touch.  

Popular upscale card, art, chocolate and gift shop located adjacent to the premier shopping plaza in Taos, NM. The business specializes in unique greeting cards of their own design and from small card companies across North America and Europe. They offer unique gifts and original art work by local artists and from around the world, as well as hand-made chocolates from NM chocolatiers. The business serves repeat regional clientele, as well as tourists visiting the Santa Fe and Taos art scene from around the world. Since its inception in 2002, the business set out to establish its retail store as the premier boutique for cards, local artisan works, chocolate creations and regional gift items in Taos. The company differentiated itself from the competition by creating their own line of greeting cards and unique product mix. Their upscale and unique mix of products give the store the feel of a sophisticated boutique. The business prime high traffic location, word of mouth and a stellar reputation, has enabled establishment of the store s brand. Growth potential exists in existing business model, as well expansion of pottery, spirituality/new age and local artist offerings and expansion of online sales.

Popular upscale flower, gift basket/gifts and  home decor shop located in an upscale retail shopping area of Denver. It has some of the  city's most prestigious individuals and  corporations as its clients. Since its  inception  in 2004, The business set out to establish its shop as the premier boutique for flower arrangements, gift baskets and gift/decor items in Denver. The company differentiated itself from the competition by using unusual flowers and offering sophisticated arrangements that were artistic and tasteful. Their upscale and unique gift offerings have established the feel of a sophisticated boutique. Word of mouth, participation in an exclusive wire service and a stellar reputation, has enabled them to establish their brand. Growth potential exists in existing business model, as well expansion of wedding and event business.