Typically, a bank or other financial institution acts as a fiduciary agent. These fiduciary agents typically have standard forms of escrow contracts under which they provide services. While some terms are negotiable in an escrow contract, most terms are non-negotiable with respect to the services provided by the trustee and the fiduciary agent`s liability. It is important to ask the trust agent what form of escrow agreement is with sufficient time before closing. Sellers should not be surprised if a buyer requires withholding, as is often the case with transactions. However, holdbacks should not exceed five percent of the purchase price and should focus on issues that can be resolved shortly after the closing of the transaction. [7] M&A study, p. 11. Transactions with provisions for post-closing adjustment amounted to 85% in 2012 and 82% in 2010. Earn-outs can also be used if the buyer has limited access to funds at the time of closing and needs to fund a portion of the purchase price based on the target company`s future revenues. This reduces a buyer`s reliance on third-party financing at closing and can therefore increase the number of viable bidders to buy the business, resulting in an increase in the purchase price.
Disputes can easily arise when determining the adjustment after closing, which makes the dispute settlement mechanism in the agreement very important. The parties usually appoint an independent accounting firm to act as auditor and arbitrator in the event of a dispute. This accounting firm should be consulted prior to its appointment to confirm its willingness to assume this role. Alternatively, if the identity of the independent auditors is not determined by the parties, the parties should establish the procedure for the selection of an independent accounting firm. Current financial measures used for earn-out provision benchmarks include: (i) net sales; (ii) net profit; (iii) cash flows; (iv) earnings before interest and taxes (“EBIT”); (v) earnings before interest, taxes, depreciation and amortization (“EBITDA”); (vi) earnings per share; and (vii) net equity. Of these, revenue and EBITDA are the most common. Of the transactions that included an earn-out provision in 2014, 19% used revenue and 39% used EBITDA. This represents an increase in the use of EBITDA relative to revenue as a key revenue for the period 2010 to 2014. [2] Another type of post-closing adjustment concerns the valuation of receivables included in the assets sold. The parties may agree to make adjustments based on the recoverability of such claims for a certain period after closing. To the extent that the bad debt exceeds a value adjustment for bad debts, the buyer may require a negative correction of the purchase price.
A seller often needs a certain amount of net working capital that is delivered at the closing of the transaction. Usually, working capital is estimated at this time, with final accounting being completed some time after the transaction is completed (e.B 30 to 60 days). Buyer will use the holdback as protection against accounting changes in the estimated working capital upon completion of the actual and final working capital. If the working capital is below the threshold at that time, the withholding protects the buyer because a differentiated difference would be deducted from the refund of the withholding. A retention is a portion of the purchase price paid into a third-party escrow account to serve as collateral for the buyer`s potential claims against the seller. Withholding compensation can alleviate concerns about the seller`s financial ability to cover claims after closing, if any. In particular, buyers will demand significant support if the purchase price is distributed to the seller`s shareholders after closing or if there are multiple selling shareholders. In these cases, the buyer needs the assurance that the proceeds of the purchase price are easily accessible to cover a claim without the need to make claims against multiple people who may have already given or spent the product further.
Compensation reserves are relatively common in transactions. The M&A survey found that in 2014, 77% of transactions reviewed included retention of compensation, while 89% of transactions in 2012 and 86% of transactions in 2010 included restriction. [3] An earn-out is a mechanism that provides for a conditional additional purchase price based on the company`s performance after closing. Typically, an earn-out is structured as one or more post-closing payments that are payable if certain specified benchmarks are met within certain time frames. Benchmarks may be based on financial measures such as revenue or EBITDA, or may be based on the achievement of certain other performance milestones. B, such as the number of new customers or the completion of the core product. If the target company does not reach the specified benchmark within the specified period, the buyer is exempt from conditional payments or pays a lower additional purchase price. [1] The study examined publicly available acquisition agreements for transactions entered into in 2014 in which private targets were acquired by listed companies. The final sample of the study of 117 acquisition contracts excludes agreements for transactions targeted by bankruptcy, reverse mergers and transactions that are otherwise considered unfit for inclusion. Asset transactions accounted for 17% of the study sample. The most common adjustment to the purchase price is the net working capital adjustment, which is intended to reflect the change in current assets and liabilities between the signing date and the balance sheet date. “Working capital” generally refers to the capital of an entity used in its day-to-day operations, also known as the difference between current assets minus current liabilities.
The parties negotiate the target amount of working capital that may remain in the company at the time of closing. If the parties wish the company to be sold with working capital consistent with its past practices, they generally base the target working capital on the 12-month average; However, this amount may not be appropriate if the company`s activities have changed over a 12-month period that requires more or less working capital. .