Abstract: Mergers and acquisitions sometimes fail to live up to the parties’ expectations for a variety of reasons. This article illustrates how financial experts can help buyers and sellers resolve disputes that arise after a deal closes and, more important, how they may help prevent disputes if consulted before closing about value-related provisions of the sales contract.
Settling (and preventing) post acquisition disputes
Mergers and acquisitions sometimes fail. Why? Sometimes the buyer simply forecasts unrealistic synergies between the merged companies. In other cases, the seller misrepresents the company’s closing-date financial condition and historical earnings capacity. Or, the seller might not receive as much in contingent consideration as expected because the buyer mismanaged the company or understated postacquisition financial results.
A financial expert can help the parties identify the reason a deal failed and evaluate whether it’s related to wrongdoing by another party. In addition, an expert, if hired early in the M&A process, can help the parties prevent postacquisition disputes.
Avoid unpleasant surprises
When privately held businesses are bought and sold, the parties typically withhold a portion of the payout or hold funds in an escrow account until certain financial matters can be resolved. For example, the deal may include an earnout where a portion of the sales proceeds are contingent on the acquired entity meeting certain financial benchmarks in the future.
Alternatively, to avoid unpleasant surprises after the transaction closes, a deal may call for purchase price adjustments (PPAs) to reconcile any disparities between what the seller represented in preliminary “reference” financial statements and the company’s actual results. For example, if the seller’s working capital has increased or decreased between the time of the reference financials and the closing date, the purchase price would be adjusted upward or downward on a dollar-for-dollar basis. In such cases, when a buyer discovers facts that the seller failed to disclose, the buyer may claim that the business isn’t as valuable as the seller represented it to be when the parties negotiated the purchase price.
Buyer vs. seller
Let’s take an example. A seller loses a major contract shortly before the acquisition but doesn’t disclose this fact to the buyer. The buyer might seek damages based on a revaluation of the target in light of this new information.
This is where a financial expert’s business valuation skills are critical. The buyer’s expert might testify that the loss of the contract had a material negative impact on the seller’s value and calculate damages based on the alleged diminution in value.
The seller’s expert could counter that, based on the target’s forecasts and other evidence, loss of the contract isn’t expected to hurt its future financial performance or market value. Perhaps this type of customer turnover is an ordinary part of the seller’s business. Perhaps the seller was in the process of negotiating new contracts that would replace the lost revenues.
Another important consideration is the materiality of an alleged misrepresentation. The buyer may argue that it would have paid less for the business had it known about the lost contract. But from the seller’s perspective, the loss may have had no impact on the price it was willing to accept.
In some cases, the seller’s actual performance may be relevant. If subsequent events demonstrate that the seller’s postclosing performance was consistent with the buyer’s expectations at the time the transaction was negotiated, the seller might argue that the buyer still benefited from the deal.
An ounce of prevention
Too often financial experts aren’t consulted until after an M&A deal closes. But their expertise can be essential when drafting PPA or earnout provisions. In particular, when drafting sales contracts, attorneys should consider addressing the following financial issues:
- The appropriate definition of “materiality,”
- Relevant accounting practices and standards (for example, U.S. Generally Accepted Accounting Principles (GAAP) or agreed-upon non-GAAP standards),
- Specific accounts (assets or liabilities) that the buyer has concerns about, and
- PPA and earnout formulas.
The contract should also identify the party responsible for preparing closing-date and postacquisition financial statements. For example, will they be audited by a CPA or prepared in-house?
A financial professional can help the parties identify potential sticking points during M&A negotiations, allowing them to iron out the details before closing. But if a deal doesn’t live up to the parties’ expectations, the buyer and seller shouldn’t hesitate to contact a valuation or forensic accounting professional to evaluate what went wrong — and by how much.