In most transactions, the purchase price is based on the value of the company on the day the shares or assets/liabilities are delivered by seller to buyer. This value can be derived from the company’s financial statements on the same transfer date.
Usually, these documents are not yet available on the transfer date. The parties can therefore choose to pay the estimated purchase price on the transfer date, with the agreement that this purchase price will be adjusted in accordance with the agreements in the purchase agreement as soon as the financial documents are available after the transfer date. The following purchase price adjustments are common in the Netherlands:
- purchase price adjustment based on Net Debt;
- purchase price adjustment based on working capital;
- purchase price adjustment based on net asset value;
In most transactions, the value of the company is determined on a cash-free debt-free basis. The available liquid assets (cash) and debts (debt) are not included in the valuation of the company.
In the absence of debt and cash, the enterprise value is equal to the shareholder value of the enterprise (equity value): the purchase price that the buyer will pay for the shares. This mechanism discourages the seller from paying out cash to itself as a dividend just before closing or leaving behind more debt than agreed.
Purchase price adjustment based on Net Debt
The balance of the liquid assets minus the existing debts (called net debt) is estimated by the parties on the transfer date. In most cases, estimated debt exceeds estimated cash. Therefore, the estimated net debt is deducted from the purchase price to be paid.
The parties then agree in the purchase agreement that the purchase price for the shares will be adjusted to the net debt amount through a determination of the balance sheet on the transfer date of the target company (the completion accounts). It is also usually neither desirable nor possible to pay off all debts and pay out all liquid assets prior to the takeover. These positions therefore remain unaffected, and the purchase price offered is then adjusted for the debts and cash available at the time of transfer.
Purchase price adjustment on the basis of working capital
In addition to applying the net debt method, a commonly used method for altering the purchase price is to adjust for changes in (exclusively) working capital. A company’s working capital is the balance of current assets (inventories including work in progress, accounts receivable and accruals) minus current liabilities (creditors and accruals) excluding cash and long-term interest-bearing debt. This balance provides an insight into the amount that is available for business operations in the short term.
The seller and buyer agree in the purchase agreement that the company must have a minimum working capital on the transfer date. A separate working capital calculation can then be made on the transfer date if there appears to be more or less working capital available on the transfer date than the amount that was agreed. This can also be determined after the completion accounts have been finalised.
The working capital method prevents the seller from taking money out of the company at the expense of the buyer, without this being passed on in the purchase price. A higher cash position due to accelerated collection of receivables or deferred payments from creditors is negated, because the working capital will fall below the agreed level. Including a guarantee with regard to working capital in the purchase agreement prevents the buyer from having to make additional capital available as working capital after closing.
Purchase price adjustment based on net asset value
A purchase price adjustment based on equity is also an option. Shareholders’ equity is equal to the balance of assets and liabilities (net asset value) on a company’s balance sheet. A buyer looks at the company’s most recent balance sheet and profit and loss statement. These figures show how the company is doing. The buyer also takes the budgets and plans of the company’s management into account in order to estimate the company’s expected future cash flows.
On the transfer date, the buyer wants the company to have at least the same amount of equity. That is why the parties prepare the closing accounts that give an idea of the current state of the company. If additional debts or obligations arise between signing and closing, they appear in the closing accounts and reduce equity by the same amount. The seller will have to pay the buyer for this difference.
For the buyer, the advantage is that any change in equity is adjusted to when the buyer entered into the transaction. The seller may have an advantage if the seller expects to still make a profit in the period between the last figures prepared and the closing (accounts). This profit can then be added to the purchase price.
There are several methods of adjusting the purchase price. Which method is most appropriate depends on the type of acquisition. The M&A lawyers at VIOTTA specialise in issues related to purchase price mechanisms and are happy to help.