Re-Jiggering the Price When Financials Change in Mid-Deal Extended due diligence and prolonged negotiations may spark a need for purchase price adjustments

Increasingly, the original purchase price hammered out by an acquirer and target may not be the actual amount that the buyer will pay at deal closing. Extended due diligence, prolonged negotiations, and regulatory hurdles lengthen the time between the signing of the deal agreement and closing, leaving more time for the seller’s financial situation to change in mid-deal and increasing the probability that a price adjustment will be needed. “Now that deals are taking longer to complete, you often see the actual realization of the projections so you can tell whether the target has been able to hit the numbers or not, at least in the short term,” says Michael Kollender, a Managing Director in Ryan Beck & Co.’s middle market investment banking group. The target’s financials may change – positively or negatively – for a variety of reasons, including introduction of new products, gaining or losing of major customers, technological advances, or enactment of new legislation. Thus the price may have to be adjusted up or down to reflect the target’s current financial situation. The difference in price often can be significant. According to John Ferro, Senior Managing Director of FTI Merger & Acquisition Advisors, that there are several key points to consider when revising a price. If the target’s performance deteriorates, he notes, the buyer has to determine whether the change will: * Be recurring, or is an isolated incident; * Have a ripple affect on other aspects of the business; * Impact the target’s margins; and * Affect the company’s profitability and/or market reputation. Conversely, if the target’s performance changes for the better, Ferro adds, the buyer must determine whether the spike is a one-time blip, or indicative of long-term improvement for the company’s bottom line, and whether the target’s current growth and profitability can be supported in the future. Of course, the buyer first has to determine whether the change alters the basic fundamentals of the deal, and whether the deal is still worth pursuing, says Peter Nachtwey, Northeast Region Managing Partner for Financial Advisory Services at Deloitte & Touche. “Boards have a lot more input on deals these days so there’s a higher level of accountability on their part. Much less bad news’ will be tolerated,” he adds. If the buyer decides to pursue a deal, despite a backslide at the target, the purchase price modification must be delicately handled so as not to become a deal-breaker. Price adjustments are used to capture the target’s true value as of the deal closing date. Experts assert that agreement by both sides on a price adjustment formula early on in negotiations can prevent squabbling later in the deal process should the price need to be fine-tuned before closing. The most recognized price adjustments formulas are based on changes in the target’s net worth, changes in net working capital, and reconciliation of intercompany accounts at the target. Of them, the most commonly used pre-closing formula, notes Kollender, is a net working capital adjustment, which is based on the difference between the target’s net working capital as of closing and an agreed-upon net working capital. If the closing net working capital is greater or less than the agreed-on net working capital, there usually be will a dollar-for-dollar adjustment to the original price, he adds. Today, there is more documenting of every facet of the deal, says Phil Comerford, a Managing Director and head of ING’s Acquisition Finance Group. Therefore, a key consideration is to make sure the accountants are actively involved in defining the price adjustment method so that after the deal, “the steps can be retraced,” in the event that questions arise at a later date, he asserts. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com