Ameliah McLaren Parker

Consideration can take various forms and can be given in a variety of ways.  Sellers will want to ensure they get a fair price for the company they are selling (the “target”) and buyers will want to ensure that the target is worth every penny.

The following mechanisms are regularly used to ensure just that:

Earn-Out

One way that buyers can ensure they are getting the true value of the target they seek to acquire is by way of an earn-out provision. In simple terms, the payment of the deferred consideration is dependent on the performance of the target company post-completion.  For example, if the business hits an agreed financial target by a certain date, the buyer will pay to the seller a specified amount.

It will be in the interests of the seller to ensure that the company’s profits are not artificially deflated by the buyer (as this would decrease the amount to be paid to the seller).  A good way to deal with this risk is to insert provisions into the purchase agreement imposing obligations on the buyer to conduct the business of the target in a specific way.  The seller may even want to enter into a consultancy agreement with the buyer in order to retain some level of oversight.

Completion Accounts

Where stock and profits in the target fluctuate regularly, the value of the target can change significantly between the negotiation and completion stage of a transaction.  Both parties will want to ensure they are paying for or receiving the true value of what the target is worth.

Completion accounts are drawn up following completion to ensure that the consideration reflects the true value of the target.  They will reveal up-to-date financial information about the target as at the date of completion.

Once the completion accounts have been agreed, the consideration will be adjusted to take into account the difference between the estimated figures which were used to calculate the amount payable on completion and the amount set out in the agreed completion accounts.  Either party may request that some funds are held in a retention account by way of security pending the agreement of the accounts.

two people signing a document

Locked Box

The locked box approach differs from preparing completion accounts in that the value of the target is determined on a date prior to completion; this is based on a historic balance sheet date which is agreed between the parties (the “Locked Box Date”).  The Buyer will insert warranties into the purchase agreement that the seller has not stripped the target of cash since the Locked Box Date.  This is known as leakage.  The buyer can then (if necessary) bring a warranty claim against the seller if they believe there has been unpermitted leakage since the Locked Box Date.

Warranties and Indemnities

Buyers can also make claims against the sellers for breach of the warranties and indemnities in the purchase agreement.  Any monies successfully claimed against a warranty or indemnity will be deemed to reduce the purchase price.  Often a portion of the purchase price is either deferred or retained for the warranty period so that funds are readily available to satisfy any such claims.

If you require any advice in relation to a sale or purchase of a company or business, please contact us on 0161 832 3304.

For more information about Ameliah and her work, please click HERE.

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