Purchase Price Adjustments: Navigating Completion Accounts & Earn-Outs

In many M&A deals, the purchase price initially agreed upon is rarely the final figure. Fluctuations in working capital, outstanding debt, or even the target’s post-closing performance can all affect how much is ultimately paid. Two common mechanisms—completion accounts and earn-outs—help adjust or defer the purchase price to more accurately reflect the business’s true value. Below, we explore how these adjustments work, common financial metrics used, and how parties can avoid disputes along the way.

Completion Accounts

1. Aligning the Final Price with Actual Balance Sheet
   • Concept: Rather than relying on historical financials (which may be outdated), completion accounts capture the target’s precise financial position at or near closing.
   • Who Prepares Them: Typically, the buyer or a neutral accountant compiles these accounts post-closing, subject to the seller’s review or challenge.
2. Timeline & Process
   • Preparation Window: A set period (e.g., 30–90 days post-closing) allows time to finalize the target’s closing balance sheet.
   • Review & Objection: The seller can contest calculations if they believe the figures deviate from agreed accounting principles.
3. Key Variables
   • Cash & Cash Equivalents: Confirms any surplus cash that might boost the final purchase price.
   • Liabilities & Accruals: Identifies unforeseen debts or obligations, reducing the seller’s net proceeds if they exist.
   • Accounting Policies: The SPA typically outlines which principles (IFRS, GAAP, or custom methods) govern the preparation of these accounts.

Practical Insight: Clear definitions of accounting standards and the timeline for review can prevent lengthy disagreements post-closing.

Working Capital & Net Debt Adjustments

1. Working Capital Targets
   • Definition: Working capital typically comprises current assets minus current liabilities (e.g., receivables, payables, inventory).
   • Adjustment Mechanics: If the actual working capital on the closing date is higher than a preset “target,” the buyer pays more; if it’s lower, the purchase price is reduced.
2. Net Debt Considerations
   • Net Debt = Total Debt – Cash: A negative net debt (cash surplus) can increase the final price, while high debt levels decrease it.
   • Lender Consents: Where external debt is refinanced at closing, the final net debt figure can be influenced by early repayment penalties or interest accruals.
3. Importance of Clear Definitions
   • Inclusions/Exclusions: Parties must agree on whether certain items (like off-balance-sheet liabilities, derivative instruments) count toward net debt.
   • Forecasting & Invoicing Cycles: Seasonal or sector-based variations in payables/receivables can significantly affect working capital at any snapshot in time.

Earn-Outs / Deferred Payments

1. Linking Price to Future Performance
   • Rationale: When the buyer is uncertain about the target’s growth prospects or reliant on key individuals, part of the purchase price is deferred and contingent on hitting performance metrics.
   • Metrics: Common benchmarks include revenue milestones, EBITDA targets, or successful product launches.
2. Balancing Control & Incentives
   • Operational Autonomy: Earn-outs can create tensions if the buyer changes business strategies post-acquisition—potentially limiting the seller’s ability to achieve performance hurdles.
   • Retention of Key Personnel: Often, the seller’s management remains in place during the earn-out period, motivated by the potential payout.
3. Structuring & Avoiding Conflicts
   • Measurement Period: Typically 1–3 years post-closing to gauge ongoing performance.
   • Reporting & Transparency: Sellers may require visibility into financial statements during the earn-out term, ensuring fair calculations of results.

Tip: Clearly define any extraordinary events (acquisitions, divestitures, or major capital spending) that could artificially inflate or reduce performance metrics, potentially skewing earn-out payouts.

Dispute Resolution

1. Accounting Expert Determination
   • Neutral Third Party: Many SPAs specify an independent accountant or auditor to resolve disagreements over completion accounts or earn-out calculations.
   • Binding vs. Advisory: Typically, the expert’s findings are binding to expedite closure.
2. Arbitration & Escrow
   • Arbitration Clauses: In more contentious deals, parties may prefer arbitration for faster resolution.
   • Escrow Accounts: Holding back a portion of the purchase price in escrow offers a ready source of funds if final adjustments or disputes lead to price reductions.
3. Minimizing Conflicts
   • Detailed Contractual Schedules: Precisely outlining accounting methods and dispute timelines reduces misunderstandings.
   • Early Issue Escalation: Promptly addressing minor discrepancies can prevent them from becoming major standoffs.

Conclusion

Purchase price adjustments ensure the final deal cost reflects the target’s real financial condition at closing and, in some cases, performance after acquisition. Completion accounts and net debt or working capital formulas help rectify any discrepancies from the initial valuation, while earn-outs link part of the consideration to future success. Because these mechanisms can materially shift the eventual price, both buyer and seller must agree on clear methodologies and timelines. Coupled with robust dispute resolution procedures—often involving independent accountants or arbitration—price adjustments can be finalized in a timely, transparent manner that preserves trust between the parties.