Purchase price adjustment: Overview, definition, and example
What is a purchase price adjustment?
A purchase price adjustment is a clause in a purchase agreement that allows the price of a transaction to be adjusted after the deal has closed, based on certain agreed-upon criteria. This adjustment is typically used in mergers and acquisitions (M&A) or other asset purchases to account for changes in the value of assets, liabilities, or financial conditions between the time of agreement and the closing of the transaction. The purpose of a purchase price adjustment is to ensure that the final price accurately reflects the agreed-upon value, taking into consideration any changes in the company or assets being acquired.
For example, the purchase price for a company might be based on its working capital at the time of closing. If the company’s working capital is higher or lower than expected at closing, the purchase price might be adjusted to reflect that difference.
Why is a purchase price adjustment important?
A purchase price adjustment is important because it helps ensure fairness for both parties in a transaction. It prevents the buyer from overpaying or the seller from receiving less than agreed upon due to unforeseen changes in the value of assets or liabilities between the agreement and closing. This adjustment mechanism provides a way to resolve discrepancies and align the final purchase price with the true value of the business or assets.
For buyers, this clause protects them from paying more than the company or assets are actually worth at closing. For sellers, it ensures that the value agreed upon during negotiations is reflected in the final price, accounting for any changes that may occur during the process.
Understanding purchase price adjustment through an example
Imagine a buyer agrees to purchase a business for $10 million, with a purchase price adjustment clause based on the company’s working capital. At the time of agreement, both parties agree that the company’s working capital is $2 million. However, at the closing of the deal, the actual working capital is found to be $1.5 million, which is lower than anticipated. As a result, the purchase price is adjusted downward by $500,000 to reflect the difference in working capital.
In another example, a buyer agrees to purchase inventory from a seller, with the final purchase price contingent on the value of the inventory at closing. If the inventory count turns out to be higher than expected, the purchase price may be adjusted upward to reflect the increased value of the inventory.
An example of a purchase price adjustment clause
Here’s how a purchase price adjustment clause might appear in a purchase agreement:
“The Purchase Price will be adjusted at Closing based on the Final Working Capital of the Company, as determined in accordance with generally accepted accounting principles (GAAP). If the Final Working Capital is greater than the Estimated Working Capital, the Purchase Price will be increased by the difference. If the Final Working Capital is less than the Estimated Working Capital, the Purchase Price will be decreased by the difference.”
Conclusion
A purchase price adjustment ensures that both buyers and sellers are protected in transactions where the value of assets, liabilities, or financial conditions may change between the agreement and the closing date. It provides a fair mechanism for adjusting the final price to reflect the true value of the business or assets.For businesses involved in mergers, acquisitions, or asset purchases, having a purchase price adjustment clause in place ensures that the transaction price is aligned with the actual financial status at the time of closing, reducing the risk of overpayment or underpayment.
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.