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Capital Region Business Journal | March 201

LEGAL ADVICE

The purchase and sale o businesses

are a key part o the U.S. economy

and a common method by which

business owners realize the value o their

entrepreneurial eorts. Although every

sale transaction is dierent, deals oten

contain similar legal structures and provi-

sions.

A helpul resource regarding current

marketplace terms is prepared every

ew years by the Mergers & Acquisitions

Committee o the American Bar Associa-

tion. The recently released 2009 Private

Target Mergers & Acquisitions Deal Points

Study analyzes 106 publicly reported M&A 

transactions that range rom $25 million

to $500 million. Even or business sales o 

less than $25 million, the study provides a

useul benchmark o what terms and con-

ditions in an acquisition agreement may

be considered “market.”

In any acquisition, there are generally

our main parts to the denitive agree-

ment: a description o the purchase price

and terms related to what is purchased;

closing conditions; representations and

warranties o the seller regarding the tar-

get’s business; and indemnication obliga-tions o the seller ater closing. While the

study analyzes many provisions and trends

in acquisition agreements since 2004, we

will highlight the provisions described in

the study that relate to: (1) adjustments

to the cash purchase price received by the

seller; and (2) what portion o the pur-

chase price is subject to claims made by

the buyer or third parties.

Adjustments to cashreceived at closing

For the seller, the most important

term o any business sale is usually the

purchase price, and the most important

part o the purchase price is usually the

cash received at the closing. Two common

terms o deals that directly aect the cash

received at or shortly ater closing are

post-closing purchase price adjustments

and holdback escrows.

Purchase price adjustments start with

the idea that the business will have an

adequate amount o working capital at the

closing but that the various elements o 

working capital will vary rom day to day

in the normal operation o the business.

To account or those variations, and to

remove any incentive o the seller to drain

the working capital prior to closing, an

increasing majority o deals (79 percent in2009, up rom 68 percent in 2006) include

a post-closing purchase price adjustment

or variations in working capital and

sometimes other assets or liabilities such

as specied debt.

Most o the time, an estimated working

capital number is calculated by the seller

and a payment based on that number is

made at closing. Then, the buyer prepares

a post-closing balance sheet. Ater some

sort o approval and dispute resolution

process, the closing balance sheet is con-

rmed, and the buyer or seller “trues up”

the dierence between the estimate andthe nal number. In some recent deals, we

have seen buyers and sellers dier on the

calculation o working capital. One good

way to reduce the risk o diering inter-

pretations is to have a sample calculation

based on a prior balance sheet incorpo-

rated into the agreement and adjustment

process.

About 80 percent o deals include an

escrow or holdback rom the cash paid at

closing to back up the seller’s indemnity

obligations or to und any buyer obliga-

tion or a working capital adjustment. The

median amount o holdbacks was about 10

percent o transaction value. The amount

o the holdback is important but the

indemnity terms that determine how and

how much o the holdback can be claimed

by the buyer should be the primary ocus

o the seller.

Later claims of buyer or others

Indemnication obligations o the seller

can arise rom several actors but in large

part come rom obligations related to

non-assumed liabilities by the buyer and

breaches o representations and war-

ranties by the seller. For example, i the

seller represents that all o its inventory

is in good and saleable condition and it

turns out that 25 percent o the inven-

tory is obsolete, then the buyer will likely

have an indemnication claim against the

seller. Sellers can limit their indemnica-

tion obligations ater the sale in two main

ways. First, the agreement can establish an

overall indemnication cap; and second,

the buyer and seller can establish what iscalled a “basket.”

An indemnication cap limits the

overall liability o the seller ater the clos-

ing, and 92 percent o the deals analyzed

included a cap. O those transactions,

the cap equaled the transaction price

in 4 percent o the deals (down rom 7 

percent in 2006 and 14 percent in 2004),

and the transaction caps were less than

the purchase price in 86 percent o the

transactions (as compared to 88 percent in

2006 and 74 percent in 2004). The mean

cap was 21.72 percent and the median cap

was 11.19 percent o the transaction value.However, even when agreements include

caps, the agreement will also exclude som

claims that are not subject to the cap,

such as raud and the breach o certain

key covenants. Generally, caps will be a

smaller percentage when the purchase

price is larger. Given the buyers’ market in

2008 and 2009, indemnication caps have

trended upward.

Another way to limit liability or the

seller is to establish a “basket.” When a

Study gives inside look at trendsin mergers and acquisitions

Rochelle h. KlasKin

and Paul J. KaRchare shareholders and members of Godfrey &Kahn’s Corporate Practice Group. For moreinformation, Rochelle can be reached at 608-284-2607 or rklaskin@gklaw.com. Paul can bereached at 608-284-2252 or pkarch@gklaw.com.

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