Avoiding buyer-seller disputes that plague almost half of mergers and acquisitions – The Denver Post
It was late Friday afternoon when Roger received a call from his lawyer. Roger had sold his business for $ 7.54 million almost two months earlier. His lawyer told him that the buyer wanted the purchase price adjusted. The buyer claims that Roger has violated his warranties and representations as to the accuracy of the company’s claims. This violation affects the level of working capital of his previous company. Rogers’ breach occurred between the final due diligence review and the closing date of the transaction. Roger was shocked. He couldn’t believe what he was hearing.
Working capital true-ups, earnout provisions, and valuations of companies affected by COVID-19 are the top three areas that lead to major disputes after the contract is signed. More is happening than you think.
Mark T. Osler
Grant Thornton, the sixth largest US accounting and advisory firm, interviewed nearly 200 US M&A experts who had closed more than 1,300 transactions in the past year. The company found that nearly half of all deals were done in some form of accounting dispute. The survey found that the size of the store had little to do with the dispute. It didn’t matter if the company was $ 10 million or $ 1 billion, the complexity of the balance sheets was the main source of disputes.
Working capital is a balance sheet item. It is defined as current assets minus current liabilities. It’s easier to imagine the capital required to keep business running. A quick calculation to determine the company’s short-term liquidity position is to divide short-term assets by short-term liabilities. If the score is 1 or higher, the company can pay its short-term debt. The higher the number, the better the company’s liquidity.
Since the seller typically retains any cash in excess of the working capital requirement, it is important that the target cash amount is established.
The amount of working capital you want is important as the last thing the buyer needs to bring money into the business shortly after the purchase date is to do a paycheck or purchase inventory. Nor does the seller want to leave more money than is strictly necessary to meet the company’s daily needs. Virtually every private company transaction involves some mechanism for determining a working capital requirement. In theory, working capital disputes should never bring business to a standstill. Reasonable individuals should be able to find a reasonable formula for calculating the target amount of cash needed to meet their monthly short-term obligations.
In addition to disputes over working capital requirements, disputes over earnout calculations, vague language in purchase and sale contracts, and nowadays the ratings of companies affected by COVID-19 for disputes between buyers and sellers.
In a recent survey by Grant Thornton, a transaction attorney said, “When the economic environment deteriorates and it looks like the buyer has overpayed for a target company, the buyer will sometimes try to win money back by determining the purchase price , or by asserting claims for breach of contract “.
This is exactly what Rogers buyer claimed.
What can sellers do to avoid these common disputes?
First of all, avoid using vague language in the sales and purchase contract. I recommend that precise definitions or formula calculations are essential to avoid any misinterpretation by the buyer. The specificity of the language should be followed by a math example illustrating the written definition or formula.
Second, you show the buyer your company’s potential for future growth. Buyers like compelling stories. Provide sound pro formas with valid assumptions that do not transcend reality. I once saw a number of predictions that suggested the company could outperform the industry average by four times. When I asked about the “assumptions” to back up the projections, there weren’t any. The seller admitted that he had only guessed what he could do by funding a large business development expense.
Third, get a rating analysis from an independent rating company. Overestimating a company’s business value is a common deal killer – especially in an earnout deal structure. According to Lutz M & A, in a recent survey of business owners, 56% said “56% believed they knew the value of their business, but only 18% had an independent valuation firm do a valuation analysis.”
Fourth, be consistent. According to Forbes, an inconsistency in what you convey to the prospect can lead to disputes.
Fifth, prepare for buyer due diligence. This is one of the most important stages in the transaction process. Make sure your documents are correct.
Roger and the buyer settled their dispute two months later. Roger returned $ 156,000 to the buyer. They avoided a lengthy court battle by settling the dispute amicably.
In short, selling your business is one of the most important events of your life. Treating the areas for potential disputes as detailed above is critical to a successful outcome.
Gary Miller is the CEO of GEM Strategy Management, Inc., a merger and acquisition consultancy that serves small and medium-sized private businesses and prepares them to raise capital or sell their businesses. He can be reached at 303.409.7740 or firstname.lastname@example.org.