The first thing you’ll review in an asset purchase agreement is the total purchase price. This is the headline number your friends will want to hear, but in many transactions, it’s subject to post-closing adjustments. The actual amount you walk away with could be less.
You might have agreed to an earnout, for example, that adjusts the price based on your startup’s performance in the months or years after acquisition. You might also be subject to indemnification claims that reduce the amount you receive from any holdback or seller note.
Finally, the purchase price might be adjusted based on working capital in your business. Such adjustments exist to account for variances between the value of your startup at closing and its value as stated in the asset purchase agreement and are easy to overlook.
For example, a store selling goods to consumers often carries inventory that most buyers will want to purchase to keep the business operating. Since the amount of inventory fluctuates, there will be a mechanism to adjust the purchase price shortly after closing.
When calculating the purchase price, you and the buyer will estimate the business’s working capital from historical data to establish the baseline from which any adjustments will be made. As a result, you should work diligently to ensure your baseline is accurate.
Your estimate will be stated as a line item in the asset purchase agreement, and then the asset purchase agreement will set forth the mechanism for calculating any adjustments. The most common reasons for purchase price adjustments are below.
Most SaaS and ecommerce businesses don’t have accounts receivable, but if your startup collects revenues on deferred payment terms, you might see purchase price adjustments based on the buyer’s ability to collect on those outstanding payments as they become due.
A common mechanism in dealing with accounts receivable is to assume a certain percentage of accounts receivable will not be collected (based on historical write-off rates) and project that percentage forward to include any accounts receivable existing as of closing.
If, within a certain period, a greater or lesser amount of the accounts receivable are paid than the original assumption, the purchase price will be adjusted accordingly.
If your startup holds physical inventory (if you own an ecommerce store, for example), most buyers will want to purchase your existing inventory so that the business can continue operating smoothly after closing. But when you’re negotiating the asset purchase agreement, it’s impossible to know exactly how much inventory your business will have at closing.
To account for this, agree on a certain amount of inventory and state it clearly in the purchase agreement. Then, at closing, either you or the buyer will run an inventory report to adjust the purchase price to reflect any discrepancy between the assumed value of the inventory in the asset purchase agreement and the actual value of inventory.
Many SaaS businesses offer annual subscriptions as a way to increase upfront revenues. From the buyer’s perspective, these customers generate no revenue until they renew their subscriptions. As a result, these customers can only cost the buyer money during their subscriptions through customer support tickets and the like.
If your startup has many prepaid annual subscriptions, be prepared for the buyer to ask for a reduction in purchase price to account for the ongoing operating liabilities they’ll assume. Your negotiation will depend on many factors such as the number and age of subscriptions, churn or melt rate, and the percentage of customers on annual subscriptions.
Avoiding Problems with Purchase Price Adjustments
Since purchase price adjustments affect the amount of money you receive when selling your startup, the last thing you want is to disagree on calculations. To avoid this, be as specific as possible in detailing the procedures to determine any purchase price adjustment.
The time and date used for determining the purchase price adjustment are often when you formally close. It doesn’t have to be the exact moment, but you need an exact time. You might also need to pause operations briefly while you count inventory and make the relevant calculations. Software simplifies this process but you still need to do it.
Minimizing the risk of disputes also includes agreeing on how you’ll resolve them were they to occur. Normally, the buyer will be the one who prepares the paperwork supporting any purchase price adjustment (you may hear this referred to as a closing statement). After that paperwork is sent to you, you will have a period to review the closing statement (30 days is common but there might be fewer in smaller transactions).
If a dispute occurs, try to work with the buyer to resolve it. To defuse tensions before they rise, you could agree in advance to mediation or arbitration in the event of a potential dispute by putting such a clause in the asset purchase agreement. Purchase price adjustments are not something you want to have to resolve in court given the time and expense of litigation.
After all the hard work you put into negotiating an asset purchase agreement, it would be a shame for your payout to fall short of expectations due to a purchase price adjustment. To ensure any proposed adjustments are fair, consider hiring one of our approved attorneys or M&A advisors to review the purchase agreement with you.
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