Despite the impact of the pandemic, the Australian private Merger and Acquisitions market was surprisingly strong in 2020 and 2021, with no signs of slowing in 2022 despite looming interest rate rises. 

Our M&A team takes a look at some of the key items you need to consider in an unregulated exit event involving a share sale or share purchase agreement (SPA).

 

1. Purchase Price: Completion Accounts vs Locked Box

In such a transaction, the buyer may look at various methods of calculating how working capital and net debt interacts with the purchase price. The amount paid as the ‘purchase price’ may go up or down depending on the calculations and the wording of the legal agreements.

Generally, the offer price for a company’s shares is inclusive of working capital. This is loosely the difference between a company’s current assets — such as cash, accounts receivable/customers’ unpaid bills or inventory — and its current liabilities, such as accounts payable and debts. This is the amount the company needs to carry on business as usual.

The other common offer requirement, subject to the working capital being included, of course, is that the company is debt-free and cash-free at completion. So “net debt’ is calculated by subtracting a company’s total cash and cash equivalents from its total short-term and long-term debt.

Corporate advisors and accountants often spend a lot of useful time negotiating how these calculations interact and how they are ultimately decided.

Whilst there are other legal mechanisms for determining these calculations, there are two common approaches: the post-completion accounts and locked box mechanisms. 

Post–Completion Accounts

The post-completion accounts mechanism involves a best estimate payable at completion and a later post-completion calculation to determine if it was correct. 

The parties agree on a formula to be used in calculating the adjustment on the day of completion, even though the actual number is not known at that time.

The parties make a ‘best guess’ of the adjustment based on the agreed formula and the latest financials at hand. 

Often 60 to 90 days later, one of the parties will have the obligation to submit the actual calculations as of the day of completion so as to “true up” the best guess estimate agreed before completion. If the estimate of the adjustment was higher than the actual number, the buyer will make a further payment to the seller. If the estimate is lower than the actual number, the seller will pay (or repay) the buyer the difference.

There are usually dispute resolution mechanisms included in the legal agreement in case the parties’ advisers cannot agree on the ‘true up’.

Locked Box Transaction

In a locked box transaction, the adjustment amount for working capital/net debt is calculated based on a set of accounts prepared on a specific date prior to completion. The amount is ‘locked’ based on those earlier accounts, which provides each party with a degree of certainty on the ultimate purchase price. This might be reassuring for parties that have gone through a competitive bidding process.

In this scenario, it is important that the buyer ensures that the working capital/net debt position of the Company is not eroded between the locked box date and the actual date of completion. Accordingly, the SPA generally prohibits the seller from engaging in any activities from the locked box date which would result in ‘leakage’ – typically any transactions, payments or disposals outside of the ordinary course of business. Any ‘leakage’ is generally a deduction to the purchase price in favour of the buyer. 

The seller will commonly look to negotiate carve-outs to the leakage provisions in the SPA, generally referred to as ‘permitted leakage’, for example, whether payment of the seller’s legal, accounting, tax and other advice is ‘permitted leakage’ and therefore such costs are not deducted from the purchase price.      

2. Warranties and Limitations

One of the more commonly negotiated provisions in the SPA is the set of warranties the seller provides the buyer, and the limitations and qualifications on where a buyer may make a warranty claim.

Warranties operate as a surety against any ‘skeletons in the closet’ that are often a concern of a buyer acquiring the shares in a company (and the potential liabilities of that company).

For a buyer, the seller must provide them sufficient comfort so as to reassure them they are getting what they paid for with no nasty surprises. The buyer is relying on the warranties provided by the seller to ensure that the purchase price being paid is actually reflective of the state of affairs of the business. 

For a seller, completion is usually a culmination of their ‘blood, sweat and tears’ over many years of operation. If the buyer were to make a warranty claim or claims following completion that would effectively reduce the actual price they sold their business for, a seller may not have sold at all.

Careful consideration must be had as to the extent of the warranties provided, and the limitation regime set out in the SPA. 

An example of certain limitations are as follows:

  • to the extent that the seller has disclosed something to the buyer, the buyer should not be able to make a warranty claim. It is common for this to be limited and linked to a digital data room that the parties have used for the purposes of due diligence/disclosure; 
  • a buyer cannot make a warranty claim until a threshold damage of loss is reached; for example, a single claim must exceed a certain dollar figure (referred to as the ‘de minimis’ threshold) and the aggregate of all claims or single claim must exceed a much higher dollar figure (referred to as the ‘basket’ threshold);
  • a buyer may only make a warranty claim within a set period of time; and 
  • the maximum liability of a seller for a breach of a warranty will generally be based on a percentage of the purchase price (often limited to the amount paid).

3. Other Considerations

The commercial interests of buyers and sellers are different, and any party to a transaction must ensure that their particular interests are adequately dealt with in the term sheet negotiation phase, due diligence & disclosure process and negotiation of the SPA.

Some other common considerations in a share sale transaction include:

  • deferred payments, earn outs, bonuses or escrow agreements in addition to the pricing mechanisms referred to above;
  • the owners being employed by the company (or the buyer or a related entity) post-completion; and
  • the seller taking shares in the buyer or a related entity as part of the consideration paid in lieu of cash.

 

 

It is very important that anyone that is considering buying or selling a company engages the appropriate advisers at an early stage.

Should you wish to discuss these matters with our experienced M&A team, please contact Peter Rouse or Matthew Rouse at Rouse Lawyers 

 

Disclaimer

The information contained on this website is for general guidance on matters of interest only. The application and impact of laws can vary widely based on the specific facts involved.

Accordingly, the information on this site is provided with the understanding that the authors and publishers are not providing legal advice. As such, it should not be used as a substitute for consultation with professional legal advisers. Before making any decision or taking any action, you should consult with a professional lawyer from Rouse Lawyers.