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Purchase price adjustments via the working capital


A company transaction will often take longer than expected. Often, several months will elapse between the initial contact and the final integration of the target into the buyer’s group of companies. In order to agree a fair purchase price even over a longer period of time, contractual clauses are often used to provide adjustment mechanisms for this. These mechanisms specify what the “ordinary course of business” involves and regulate to what extent the Managing Director may make changes within the company. These arrangements apply from the time of signing the purchase contract (“signing”) to the transfer to the new owner (“closing”).

In order to understand the changes made by the Managing Director, it is necessary to either create mid-term financial statements to enable the transfer of assets, or to set the transfer date at the end of the financial year.

On the one hand, the operational assets or working capital, and on the other the net debt, both play a fundamental role in the contract negotiations and the application of the adjustment mechanisms.
We examine these two items more closely below in relation to a proper continuation of the company and their inclusion in defining the purchase price mechanisms.


Definitions of working capital and net debt

Working capital is divided into trade working capital and other working capital. The calculation is made up as follows:




The trade working capital plus other working capital constitute the total working capital. The determination of net debt is as follows:



Ordinary course of business

The term “ordinary course of business” defines to what extent seller may vary the working capital between signing and closing.

When drafting a working capital clause, you need to consider that this mechanism is required in order to maintain the value of the company, whether the same objectives cannot be achieved by means of a simpler and less restrictive mechanism, and that the managing director should not be hampered in continuing with regular business operations (e.g. in designing price strategies).

An effective clause for the “ordinary course of business” will therefore prevent the Managing Director from implementing measures that increase liquidity but run counter to the way the company was previously managed. This might mean, for example, delaying payment of supplier invoices in order to artificially inflate the bank balances.


Influencing factors

The challenge when agreeing on a working capital clause lies in defining a suitable reference value.
To achieve a realistic view of working capital, the accounting records must reflect changes accurately and the business model must be stable and cyclical.

In addition, historical values can be distorted by special effects, such as by high write-downs following an inventory count, or a high level of receivables due to a sharp increase in sales. However, future external developments must also be taken into consideration, such as an economic downturn or price increases by suppliers. If the previous year values can be adjusted suitably, a proper reference value must be specified which corresponds to the level in the previous year or the median value of the three previous financial years.

If the parties were able agree on a common reference value, then the next step is to agree how large any deviation can be and still be judged to lie within the “ordinary course of business”. This bandwidth of flexibility could vary within an absolute or a percentage range.

Where possible, special cases and/or events should also be taken into account when these are already foreseeable and when they may affect the level of working capital. One example of this is the number of public holidays at the end of the year that fall on a weekend, which will vary annually. If there are more business days at the end of the current year, then the accounting department has less time available to settle outstanding supplier invoices, so that ceteris paribus the level of cash funds and the accounts payable will be higher than in the previous year. This then impacts the working capital and the purchase price adjustment mechanism, even if the managing director had no intention of doing so.



Purchase price adjustment clauses are an important element when dealing with business takeover transactions and, when correctly applied, justify their existence by delivering a purchase price that is fair for both parties.

However, the risk of conflict is high, since both parties often interpret the “ordinary course of business” differently. It is therefore essential to start analysing working capital as part of a due diligence and to incorporate the insights gained in the purchase price negotiations. It is thus advisable to seek a solution that is acceptable to both parties, and to draft clauses as precisely as possible in order to avoid additional negotiations and potential disputes at a later date. 

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