An often under-considered but financially crucial aspect of any M&A transaction is in factoring the complexities and potential ramifications of how post-closing adjustments and escrows can impact the final purchase price of a deal. The process of agreeing to post closing terms between two parties of lawyers and advisors is almost always fraught with surprises, pitfalls, and the need for a push/pull and compromise of terms.
We thought it valuable to ask two seasoned experts—one in negotiating and advising deals, and the other with personal experience in recently selling his company—to share their general insights on terms and navigating the intricate landscape of working capital adjustments, earn-outs, and safeguarding buyers through escrows.
Post-Closing Adjustments: An Often-Overlooked Component of Every Deal
Post-closing adjustments are an integral part of purchase and sale transactions, with the potential to significantly alter the final purchase price. These adjustments, ranging from working capital true-ups, earn-outs, income and expenses, asset and liability concerns, and more, can play a pivotal role in shaping the financial outcome of an M&A deal even after an agreed upon purchase price has been reached.
With deal documents sometimes reaching over a thousand pages of dense legalese, reading every sentence and deciphering the fine print can become a herculean task that only an experienced advisor can successfully traverse.
Decoding Working Capital Adjustments
Working capital adjustments involve a nuanced negotiation between buyer and seller. The target net working capital, established in the purchase agreement, serves as the baseline, while post-closing adjustments are made based on the variance from this target—designed to provide a mechanism to align the final purchase price with the actual assets and liabilities of the acquired business delivered at closing or retained by the seller.
Insights from Real-Life Transactions
In many ways, these negotiations are a process that can only be fully understood by going through it yourself. In our own experiences in selling our companies, even with seasoned advisors and a clear understanding of the steps involved, we were often surprised by issues that arose and blind spots we had—saved only by our advisors who had seen it before and knew how to step around the many pitfalls.
CEOs and CFOs who have been through this universally emphasize the fundamental importance of due diligence, understanding the specific terms of working capital, and a proactive and unemotional negotiation to ensure a fair outcome for all parties involved.
Escrows: A Safety Net for Buyers
Escrows are used as a protective mechanism for buyers, withholding a portion of the purchase price for a defined period post-closing. This period allows for a thorough assessment of any unforeseen liabilities that may be attached to the company being purchased, providing buyers with a safety net against contingent risks.
A well-structured escrow arrangement contributes to a smoother post-closing process, and striking compromises around negotiated risks should be expected.
Key Takeaways for Business Owners
In the realm of M&A transactions, seasoned experts who understand the complexities of the process as both advisors and sellers of their own businesses can offer invaluable advice for business owners—able to give insight not only on the details and timeline of deal negotiations, but also on the emotional toll and expectation management of the humans behind it.
At Dunn Rush & Co., we emphasize the need for a comprehensive understanding of transaction documents and stress the significance of assembling a robust advisory team who know how to navigate the minute details involved in getting a transaction completed successfully. Proactive disclosure, negotiation, and collaboration with experts in investment banking, law, accounting, and tax planning are essential elements for success in all M&A deals.
Mastering post-closing adjustments and escrows requires strategic thinking, thorough preparation, and expert guidance. It is not a process where sellers are likely to be rewarded for going it alone, as seemingly insignificant details can result in costly negative price adjustments post-closing. Business owners can best navigate this complex terrain with confidence by embracing these insights and adopting a proactive approach to negotiations and due diligence.
To hear many more insights and advice on these topics, listen to our new podcast where Jim Thomasch and Steve Smith, of Dunn Rush & Co., get into the weeds, share their personal M&A journeys, and highlight the role that our advisory teams played in reaching successful outcomes.