Post-closing purchase price adjustment: Overview, definition, and example
What is a post-closing purchase price adjustment?
A post-closing purchase price adjustment is a provision in a merger or acquisition (M&A) agreement that allows for the purchase price to be adjusted after the deal has closed based on the actual financial performance or conditions of the business being sold. The adjustment typically depends on certain factors such as working capital, debt, or other financial metrics that were estimated or agreed upon prior to the closing but may differ at the time the transaction is completed.
For example, the purchase price might be based on an estimate of the target company’s net working capital at the time of closing, with a post-closing adjustment made to account for any discrepancies between the estimate and the actual amount.
Why is a post-closing purchase price adjustment important?
A post-closing purchase price adjustment is important because it ensures that both the buyer and the seller are protected against any changes in the business’s financial situation between the signing of the agreement and the actual closing of the transaction. This adjustment allows for a fairer transaction by taking into account the final, verifiable financial position of the business being acquired.
For buyers, it provides a mechanism to adjust the price if the business’s financials were inaccurately represented during negotiations, such as overestimated working capital or liabilities. For sellers, it offers a way to finalize the purchase price based on real figures, preventing them from losing value due to adjustments after the deal is closed.
Understanding post-closing purchase price adjustment through an example
Imagine a company is acquiring another business for $10 million, with the purchase price contingent on the target company’s working capital being $2 million at the time of closing. After the deal is completed, the buyer reviews the final financials and discovers that the working capital is only $1.8 million. As a result, the purchase price is adjusted downward by $200,000 to reflect the lower working capital.
In another example, an acquisition agreement includes a provision for a post-closing purchase price adjustment based on the debt level of the target company. After closing, it’s discovered that the target company has $500,000 more debt than anticipated. In this case, the purchase price would be adjusted upward by that amount, as the buyer must assume the additional debt.
Example of post-closing purchase price adjustment clause
Here’s what a post-closing purchase price adjustment clause might look like in a purchase agreement:
“The parties agree that the final purchase price for the transaction shall be subject to a post-closing adjustment based on the actual working capital of the Company as of the Closing Date, as calculated in accordance with the agreed-upon accounting principles. If the final working capital differs from the estimated working capital by more than [X]%, the purchase price shall be adjusted upward or downward accordingly, with such adjustment to be made within [X] days of the Closing Date.”
Conclusion
A post-closing purchase price adjustment is a critical element in M&A transactions, providing both parties with a fair and balanced way to finalize the purchase price based on actual financial conditions. It protects both the buyer and seller from unexpected changes in the target company’s financial position, ensuring that the transaction accurately reflects the value of the business.
For buyers, this adjustment mechanism ensures that they are not overpaying for the business, while for sellers, it allows for a fair settlement based on real, post-closing financials.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.