Module 9 Flashcards
why is it important to clearly define anything that may impact the definition of cash flow between buyer and vendor? (3)
triggering events for potential earn out adjustments are often linked to EBITDA - even if clearly defined (such as GAAP measures), this would include some grey area in which should be clearly identified
post-close working capital adjustments are common in PE deals when closing WC differs from an assumed, “normal” level of working capital - these adjustments should be agreed to beforehand
any assets/liabilities that are excluded from transaction
what are 5 common areas of purchase price adjustments that should be agreed upon at close for either the present or future?
if debt balances are to translate into a negative PPA, illustrating fair value of debt calculation
if cash accounts translate into a positive position for the PPA, as well as any FX adjustments
if pension deficits, enviro liabilities, and other unfunded liabilities are to be “debt like” (negative on PPA)
if cash balances (depending on nature of balance) are be positive or negative, ie, deferred revenue or customer deposits
capital lease classifications - usually negative but could be excluded if transacting parties agree
what are the 4 most key factors to take into account for establishing “normal WC” as it relates to purchase price adjustments ?
buyers want higher NWC need, as it reduces likelihood they will have to pay a positive PPA
TTM average WC (cash free debt free) is often a starting point for determining normal WC, but seasonality and growth must be considered (differing time periods may be more appropriate)
closing date working capital balances take time to compute and are not known at closing
buyers and sellers may calculate the WC adjustment on closing date with the intent of a true-up post-close adjustment
what is a holdback?
refers to a sum of proceeds that are initially held back from a vendor until a certain element of transaction risk can be validated post-closing
what are the general conditions on holdbacks? (6)
if the holdback period elapses without a triggering event, holdback is released
if an adverse triggering event occurs, the holdback proceeds are used to pay the triggered liabilities before being released to the vendor
typically they are placed with an escrow agent are not typically treated like deferred financing from the buyer
they are a point of negotiation often ranging between 0 and 20% of vendor proceeds for a specified period
may be subject to litigation, WC adjustments, tax liabilities, enviro liabilities, etc.
nature of the holdback triggering event will often determine the length of the holdback period - WC may only be 3-6mos but for litigation may be years
what should be noted in relation to VTBs and earnouts as means of contingent consideration (5)
issues can arise from maturity, payment frequency, interest rate, and subordination, relative to other debts
buyers are naturally incentivized to negotiate for longer maturities, bullet repayment, low interest rates, and subordination
VTBs effectively transfer risk to vendor, as payment may be contingent on future performance. as such, they are more common in smaller or riskier deals
earn outs transfer risk to vendors to a much greater extent than VTBs - even when robust, there is risk of no payment to vendor
critical that legal documents reflect the motivations of the earn out in full - specifics around revenue (ie. currency, intercompany sales, etc.)
what are the usual 8 reps and warranties ?
vendor has title to shares
vendor has authority to transact
no shares or claims on equity are authorized or outstanding other than disclosed in the company corporate record book
no liens or encumbrances other than disclosed
compliance with laws
no undisclosed liabilities
corporate record book is complete and up to date
company is not involved in any legal proceedings
what are the four main areas that buyers look for affirmation in representation from a vendor?
financial statements are a fair representation
statement that a company’s assets are sufficient to meet the needs of the business going forwards
statement surrounding the confidence on the projected results - this is sometimes difficult and the vendor should be careful not to expose themselves to undue risk
statements surrounding quality of specific assets, such as that they are saleable, A/R in good condition, business premises are in good order, and assets are free of impairment
what are the three major areas that “qualification statements” can be made in lieu of an absolute representation?
materiality threshold - vendor negotiates a representation that is qualified by a percentage of the purchase price for example
MAC clause - material adverse change, vendors with a strong position may qualify an event that could potentially change the economic position for entering into a transaction (example given is on transactions that take government or regulatory approval or obtain other third party consent)
knowledge - a vendor may not be in a position to comment on the accounting treatment that a company follows and as a compromise, vendors may provide representations that are limited to the knowledge of the vendor in their capacity as an owner or a member of management
what are survival periods ?
they detail the time permitted for a potential liability to arise - general reps are usually given 2 years or less to survive, while specific reps like tax-related may have longer, aka equal to statutory limitations
what are the two types of closing covenants as it relates to transactions and related PPA and what are some examples of each?
pre-closing covenants
such as update disclosure schedules
provide notice of any breach of reps or warranty
continue operating in ordinary course of business
not discuss the purchase or sale of shares or
assets
post-closing covenants
continue operating in normal course of business
maintain books and records of company
prepare tax returns in accordance with tax law
maintain historical acct treatment
