M&A Activity is Expected to Rise The CFOs Role in Minimizing Post-Acquisition Disputes

As we’ve discussed in earlier posts, our annual Retail Compass Survey of CFOs found that the retail industry is poised for another year of heavy deal flow with 94% of retail CFOs surveyed expecting M&A activity to increase or remain steady in 2013. With such a high expectation of M&A activity, it is important for CFOs involved in these transactions to understand the post-acquisition dispute issues that often arise after closing.  If these issues are proactively considered before an agreement is reached, CFOs can minimize the chances of being distracted with such disputes post-closing and can instead focus on integrating the newly acquired business, driving operational efficiency and setting the company on a path for growth.

M&A agreements often contain an adjustment to the purchase price that occurs post-closing, which reflects changes in the balance sheet of the company being sold from the date a deal is negotiated to the date the transaction closes. While the metrics for adjustment vary from one agreement to the next, a common adjustment is based on the change in a business’s Net Working Capital. Disputes often arise because the Buyer and Seller have different opinions regarding the amounts that should be included on the Closing Date Balance Sheet. These disputes often focus on generally accepted accounting principles (“GAAP”) and their application within the context of the terms of the M&A agreement.

For example, M&A agreements may contain language that requires the Closing Date Balance Sheet to be prepared in accordance with GAAP and consistent with a company’s past policies, practices and procedures.  Post-closing purchase price adjustment disputes often arise when a company’s past practice was not in accordance with GAAP because the M&A agreement is silent on which should prevail—past practice or GAAP.  CFOs can help to minimize related disputes by suggesting that clarifying language be included in the agreement which specifies which prevails.

When drafting an M&A agreement, parties often believe that the “GAAP consistent with a company’s past policies, practices and procedures” language is sufficient to prepare the Closing Date Balance Sheet. As CFOs are aware, GAAP requires management to make certain judgments and estimates in order to prepare financial statements. However, the Buyer and Seller’s respective management teams may have differing estimates for the same balance sheet item, though they are both in accordance with GAAP. Another often-disputed item when determining the post-closing purchase price adjustment is the establishment of an appropriate reserve for excess and obsolete inventory on the Closing Date Balance Sheet. CFOs involved in an M&A transaction may want to suggest the inclusion of language in the agreement that removes the subjective nature of the estimate for the reserve for excess and obsolete inventory. For example, the parties involved in the transaction can agree on a formula based on the age of the inventory to determine the amount of the excess and obsolete inventory to be recorded on the Closing Date Balance Sheet.

CFOs serve as a valuable resource to the attorneys throughout the process of drafting the M&A agreement. An understanding that M&A agreements are subject to interpretation and disagreement between the Buyer and Seller often helps to minimize post-acquisition disputes, allowing CFOs to focus on their businesses.