Kerr Russell’s Kevin Block and Kenneth Lombardo are featured in the May/June 2018 issue of DBusiness Magazine. The theme of the section is “Mergers & Acquisitions: Q&A.”
Their responses follow:
Question: How do the parties to a business acquisition typically adjust the purchase price to account for the changes in financial condition during the period between establishing the purchase price and closing?
Kevin Block: A working capital adjustment is a typical approach to adjust the purchase price to address changes in financial condition between the date the purchase price is established and the closing. Working capital adjustments usually occur after closing and involve an adjustment of the purchase price based on the amount by which the actual working capital at closing exceeds, or is less than, an established working capital target.
The basis for the adjustment is that the purchase price assumes a certain level of working capital is necessary to run the business. If the seller delivers a working capital in excess of the target working capital, then the seller is entitled to the excess. If the seller delivers working capital less than the target working capital, then the buyer is entitled to a refund of a portion of the purchase price. It is important for the parties to establish the methodology to determine the final working capital, including whether a physical inventory will be conducted as part of the process, to avoid post-closing disputes.
Question: I am in the process of selling my business. How can I minimize my potential post-closing indemnification obligations to the purchaser for breaches of the representations and warranties?
Kenneth Lombardo: When I represent the seller of a business, I attempt to minimize the seller’s potential post-closing indemnification obligations to the buyer by shortening the survival periods for the representations and warranties and insisting on a deductible or basket and payment cap.
The shorter the survival period, the less amount of time the buyer has to assert an indemnification claim.
By including a deductible or basket, the buyer is precluded from seeking indemnification from the seller until the aggregate amount of all of the buyer’s damages resulting from a breach of a representation or warranty exceeds a specific dollar amount (usually a percentage of the purchase price).
A mini-deductible can also be used to prevent the buyer from bringing an indemnification claim for a de minimis amount (e.g. less than $10,000).
Finally, by including a payment cap (also usually a percentage of the purchase price), the seller’s maximum potential liability to the buyer is limited. For certain deals, requiring the buyer to purchase buyer-side representation and warranty insurance should also be considered.