Article
Transaction advisory: Dispute causes and how an independent accountant can help
Feb. 23, 2022 · Authored by Luc Arsenault
Low interest rates, buyers sitting on record levels of investable cash, and a shortage of sellers are key factors driving one of the most competitive mergers and acquisitions (M&A) markets in recent history.
In the rush to pursue opportunities as they arise, key details are often left out of the purchase-agreement terms. This can result in expensive litigation when the parties discover unpleasant surprises after signing the agreements.
The following is an exploration of common M&A transaction discrepancies, considerations to improve your purchase agreement, and how an independent accountant can help companies resolve these issues.
M&A strategy closing adjustments trends
Parties are spending more time and attention on defining closing adjustments to limit the latitude buyers and sellers have when devising post-closing calculations.
Typically, most M&A transactions are based on the company being delivered with the following criteria:
- On a cash-free, debt-free basis
- With a normal level of net working capital (NWC) needed to operate the business without additional contribution
- With each party paying their own transaction expenses, such as advisor fees, brokers’ commissions, or spreads
At times, parties use earn-out provisions — a contractual agreement to pay some or all the purchase price if certain milestones are achieved post-close — to bridge the valuation gap. As such, parties could potentially need to reconcile five or more accounts and items after the transaction.
The cash, debt, and transaction expense components of the M&A process are typically easier to reconcile. NWC calculations and earn-out provisions, however, require more definitions and precision due to the number of accounts included in their determination.
To address these potential complications, parties can define NWC and the earn-out provision, including a sample calculation, in the purchase agreement.
Common causes of M&A process closing adjustment disputes
The causes of a dispute can vary between NWC closing adjustments and earn-out provisions. These examples show how a lack of specificity can lead to M&A strategy confusion.
NWC adjustments
For NWC, omitting a description of calculation methods for accounting estimates such as bad debt expenses and inventory reserves can lead to disputes.
Too often, buyer and seller rely on a general definition stating that the earn-out and NWC calculations are prepared in accordance with generally accepted accounting principles (GAAP). However, GAAP provides the framework for certain accounts but not the formula
M&A strategy: How to improve purchase agreements
Well-written agreements prepared for M&A transactions specify the conditions required to execute the transaction. Effective agreements proactively consider, and thoroughly evaluate, potential issues that may arise after the transaction closes.
To lessen the chance of a dispute and improve an M&A agreement, consider the following when preparing the agreement.
Five ways to proactively avoid potential M&A process issues
- Avoid vague terminology
- Delineate financial reporting and other cutoff deadlines
- Include calculation methodology examples or descriptions for commonly disputed areas
- Complete buy-side or sell-side due diligence before a transaction
- Work with experienced M&A legal advisors who collaborate closely with the accounting and tax diligence team on the transaction
Independent accountant dispute resolution
In some cases, M&A transaction disagreements can be quickly resolved through the buyer and seller reaching a compromise. In other situations, disagreements may escalate, leading to disputes.
When the parties can’t agree on the closing adjustments, the purchase agreement describes the resolution process, which in most cases refers the matter to an independent accountant. The role of the independent accountant, as the transaction advisory, is to provide an objective, unbiased, and conflict-free determination of the closing-adjustment accounting based on the purchase agreement.
The determination is based on the purchase agreement contract regardless of intent or fairness. Typically, the purchase agreement states the independent accountant determination should be within the range presented by the parties. The independent accountant typically can’t conclude lower or higher than the disagreement range.
Preparing for a closing adjustment dispute
To smoothly resolve an M&A transaction adjustment dispute, it’s important for buyer and seller to approach the conflict in the following ways:
Managing transaction risk through comprehensive due diligence
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.