Monday, 16 February 2015

SPA Series Part 7: How To Negotiate M&A Deals In Finland - Purchase Price and Adjustments

So there have been some delays in my writing but now it is time to continue. This time I will discuss some key issues to consider when using a fixed purchase price model, some main principles behind net debt and net working capital and their interplay, as well as the idea behind a purchase price adjustments clause. The reason for the delay has been purely due to some interesting projects we have had a pleasure of doing in the final quarter of 2014 and beginning of this year in security, telecom, cleantech and energy sectors which definitely seem to be active in Finland (see more from here).
Right, to our real topic. Next in our series we head toward one of the most critical clauses in a Share Purchase Agreement, namely the purchase price. There are many options and variation, and I will first try to cover some of these most common models below and then focus on fixed price and preliminary purchase price with purchase price adjustment (PPA). It goes without saying that this is not only a legal exercise but should also be discussed with financial advisors and the client.
We could start with a fixed price model which is typically a type of a derivative from the target’s balance sheet. Naturally it needs to be understood which date is in question but there is also a connection to warranties or conduct of business prior to closing, namely, that the seller should be prevented from taking action which would be outside the ordinary course of business. This is not the only issue to consider if you are a purchaser, as that would just make life too simple. There is a possibility that the seller might wish to take funds or assets out of the company or distribute dividend after the fixed date, which naturally might be outside the ordinary scope of business but not necessarily. If you have a representation or warranty regarding conduct of business before closing or another clause to this effect, one should also keep in mind that if there is a leakage, should a de minimis clause (relating to limitations of liability, such as like individual claims or baskets) apply or not.
Secondly, a fixed purchase price does not always work and sometimes a preliminary purchase price payable at closing with the later purchase price adjustment is the way forward. Three key points to remember here:
  • Connection between net debt and net working capital – if there is net debt and it increases, then the net working capital should decrease and the other way around
  • Could you use net debt only? Well you could, but that increases the seller’s possibilities to manipulate the purchase price by decreasing debt and therefore consequently increasing the purchase price.
  • So if these work together, the seller’s possibilities to influence price mechanisms are limited.
The financial models do not always follow these legally simplest ways of dealing with purchase price adjustments, and you could have a situation where there is only net debt without working capital. If this is the case one should only have an additional clause preventing seller from manipulating the net working capital (and therefore decreasing the net debt).
Well, how, then, is the adjustment actually calculated? Typically the buyer wishes to control the calculation and there are limitations to the seller’s objections. In the simplest form the clause could state:
"These net debt and net working capital calculations will be prepared by us as the buyer. When preparing these, we use the closing statements as basis and prepare these with the company’s auditor. We promise to deliver these to you within X days after closing has taken place. If we fail to deliver these to you, you are allowed to prepare these."
Further, the clause should state how disputes are solved if the parties fail to agree on this.
We will continue next time with payment clause, escrow and earn-out but in the meanwhile splendid winter season!