Joel Espelien

Thanks. These issues can be particularly challenging in cross-border deals. Continuing on this theme, let's hear more from Jeff Brown in Houston on working capital and balance sheet adjustments.

Jeff Brown

So, you thought you negotiated the price for your company but think again. The purchase agreement determines how the balance sheet will be treated, and that treatment will result in a price adjustment. There's lots of value in your balance sheet, and the way that it's divided up will impact the amount of money you put in your pocket or leave for the buyer.

The two popular methods for dividing up the balance sheet are called block box and completion accounts. The block box method is more popular outside the US. Neither method is intended to alter the amount saved for the business, but in practice it can.

And here are some pitfalls. Structure language that says the transaction will be done on a cash-free, debt-free basis, with a normalized level of working capital is not enough. Sounds like the seller gets all the cash and pays all the debt. But that's not exactly true. Every business needs a certain amount of working capital. And that amount may change with seasonality, product price, or margin cycles. So what's normal? Also be sure you and the buyer are using the same accounting math. The buyer may want to classify some of your short-term deferred revenue as long-term and a liability, resulting in a balance sheet adjustment against you.

Joel Espelien

Thanks, Jeff. We see those issues in nearly every deal. Next, we turn to Rob Schram here in Seattle, on the all-important question of the escrow holdback, the money that you don't get at the close.

Rob Schram

To satisfy potential future indemnity claims that are detailed within the indemnification section of the agreement, a portion of the purchase price is typically withheld in the form of an escrow, held by a third-party or a holdback held by the buyer. Escrow terms describe the percentage of the consideration withheld, the duration of the obligation, known as the survival period, how and by whom the escrow is to be funded and so forth. To prevent death by a thousand cuts, often a basket provision is included that outlines the minimum amount of damage the buyer must sustain before the seller is required to pay for losses. Finally, a cap provision places a limit on the aggregate of claims drawn against the escrow. Some liabilities (for example, IRS audits, taxation, intentional fraud, etc.) remain uncapped.

Generally, we see escrow amounts in the range of 10% to 15%, and a survival period of 12 to 24 months. The exact numbers depend on the inherent risk and the likelihood of liability. But skillful negotiation around factors like an independent board of directors, solid financials, good corporate governance, et cetera, serve to mitigate risk and increase buyer confidence. One of the advantages of having multiple buyer candidates in an orchestrated engagement is that escrow, like all structural elements of the dea,l can be negotiated. We've seen escrow completely taken off the table, to sweeten the buyer's LOI and win the deal.


This is a segment from Tech M&A Monthly: Best Practices for Definitive Agreements in Tech M&A (August) webcast. For more information, please visit Corum Group's Software M&A Webcast Archive.