Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How Founders Get Trapped by M&A Purchase Price Adjustments
Transcript
- Lucas: You read the headline number on a deal — say, $75 million — and you think, that's what the founder walks away with. But in practice, the actual cash that hits their account depends on something most sellers barely look at until it's too late: the purchase price adjustment. Luna: The working capital peg, the net debt adjustment, all that fine print in Section 2 of the SPA. Lucas: Exactly. And I want to focus on a real example I saw last year — a $75 million all-cash acquisition of a B2B software company. The seller had a great business, clean financials, and a straightforward earnout structure. But the purchase price adjustment ate nearly $6 million of their payout. Luna: Six million on a seventy-five million deal — that's eight percent. How does that happen? Lucas: It comes down to how the working capital target is set. In most private M&A, the buyer requires the seller to deliver the business with a certain level of net working capital at closing — typically the average over the last twelve months. If the actual working capital at closing is below that target, the buyer deducts the shortfall from the purchase price. Luna: So the seller has to 'leave in' enough cash and receivables to meet that peg. But what if the business has been growing and receivables are lumpy? Lucas: That's exactly the problem. In this case, the seller had a big contract close in the month before signing. They collected the cash and used it to pay down a line of credit. That made their working capital look lower on the closing balance sheet, because they had less accounts receivable and more cash was used to reduce debt. Luna: Wait — they collected cash, which should be good, but because the working capital peg was based on the average, the buyer argued they were short. Lucas: Right. The buyer's definition of working capital excluded cash and debt. So the seller's collection actually reduced their net working capital. The buyer said, 'You're $4 million below the target, so we're deducting that.' Then they also found a disputed $2 million in deferred revenue that the buyer claimed should be treated as a liability. Total adjustment: $6 million. Luna: And the seller had already signed the SPA. Was there any recourse? Lucas: There's a dispute resolution process, but it's expensive and time-consuming. Typically you have sixty to ninety days to submit a closing statement, then the buyer has thirty days to object, then you go to an independent accountant if you can't agree. The seller in this case just didn't have the leverage — they'd already committed to the deal, the buyer held the cash in escrow, and the legal fees would have eaten into whatever they recovered. Luna: So the lesson is: negotiate the working capital mechanics before you sign, not after. Lucas: Exactly. And the specific things to watch are: how the target is calculated — is it a fixed dollar amount, or a formula based on trailing twelve months? What's included in the definition of working capital? And is there a 'material adverse change' clause that lets the buyer reopen the adjustment if something changes between signing and closing? Luna: Let's talk about that last point — the MAC clause. In a signing to closing gap, the buyer can claim a material adverse change and try to renegotiate the price. But how often does that actually happen? Lucas: It's rare in practice — buyers usually don't want to blow up a deal — but the threat is real. In one study by the American Bar Association, about 8% of private-target deals had a MAC invoked post-signing. And even if it's not invoked, the risk affects the adjustment. Sellers should push for a 'no MAC' clause in the adjustment section, meaning the target is locked at signing regardless of intervening events. Luna: So the adjustment is basically a second negotiation after the price is announced. The buyer can pick apart the balance sheet. Lucas: And the seller's advisers — their investment banker, their lawyer — they often focus on the headline valuation, the earnout structure, the escrow terms. But the purchase price adjustment is the one thing that hits immediately and in cash. I've seen deals where the earnout was generous but the adjustment clawed back more than the earnout ever paid out. Luna: That's brutal. So what should a founder do? Get an independent audit of the working capital target before signing? Lucas: At minimum, have your accountant run a pro forma closing balance sheet based on the defined working capital. Model a few scenarios — what if you collect a big receivable before closing? What if you defer some payables? What if you need to invest in inventory? And negotiate a 'working capital peg' that's tied to a recent historical average, not a fixed number, and define exactly what's included — cash, marketable securities, deferred revenue, all of it. Luna: And also negotiate a 'materiality' threshold for disputes — say, you only adjust if the difference is more than $100,000, so small variances don't trigger a costly fight. Lucas: Yes. And the time limit for objections — you want it short, maybe twenty days, so the buyer can't drag it out. Also, the independent accountant should be a neutral firm agreed upon in advance, and their decision should be binding on both sides. The cost should be split, but the seller can negotiate a cap. Luna: It's fascinating how much of the deal economics are determined by these procedural details. The 'price' is almost a starting point. Lucas: And that's why I keep coming back to this. If you're a founder approaching a sale, the purchase price adjustment is the part of the contract that will most directly affect the cash you walk away with. And yet, in my experience, fewer than one in three sellers actually model it before signing. Luna: Maybe because they assume the buyer is reasonable, or that the adjustment is just a formality. Lucas: Right. And look — we talk about these traps because the real world is messy. And speaking of the real world, a quick honest thing. This show doesn't have ads, and we want to keep it that way. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these. Luna: Yeah. If these conversations have moved your work forward in some small way, that's where you can help keep them going. No pressure, just the truth. Lucas: Exactly. So back to the adjustment trap. Another angle I see: the 'net debt' adjustment. Many SPAs define net debt broadly — including things like accrued bonuses, deferred compensation, even certain operating leases. If the seller hasn't cleaned up their balance sheet, the net debt adjustment can be massive. Luna: Give me an example. Lucas: I know a manufacturing company that sold for $40 million. The buyer's definition of net debt included the present value of an operating lease for a factory that had five years left. The seller thought the lease was just an operating expense, not debt. But the SPA said all leases with a term over twelve months counted. That added $1.8 million in 'debt' and reduced the purchase price. Luna: So the seller effectively paid $1.8 million for the buyer to take over the lease. But if they'd known, they might have structured the lease differently before the sale. Lucas: Exactly. You can refinance, buy out the lease, or negotiate a cap on the net debt adjustment. The key is: don't let the buyer define the terms in a way that captures things you didn't think of as debt. Luna: So before signing, have your CFO or an outside accountant run a mock closing statement using the buyer's definitions. See what the adjustment would be under normal operations. Lucas: And then negotiate from that number. If you see a $2 million expected shortfall, raise the headline price by $2 million, or negotiate a higher working capital target, or exclude certain items. The buyer may push back, but at least it's transparent. Luna: I also think sellers underestimate the importance of the 'closing statement' preparation. The seller prepares the first draft, and that sets the baseline. Lucas: Huge point. The seller's team — their CFO, their controller — needs to be ready to produce a clean, well-documented closing balance sheet within days of closing. If it's sloppy, the buyer will find discrepancies. I've seen deals where the seller's own accounting was so disorganized that they couldn't defend their numbers, and the buyer's adjustment stuck. Luna: So preparation is not just legal — it's operational. Lucas: And it starts months before the deal. I tell founders: if you're thinking of selling in the next twelve months, start cleaning up your balance sheet now. Standardize your revenue recognition, clear out old payables, reconcile intercompany accounts. The cleaner your books, the fewer adjustment surprises. Luna: What about the dispute resolution process itself? Any tips for sellers? Lucas: Negotiate the scope of the independent accountant's review. Some SPAs say the accountant can only decide between the two parties' submitted numbers — they can't come up with a third number. That's good for the seller because it forces the buyer to be reasonable. Also, put a time limit on the entire dispute process — say, 90 days from the closing statement submission. Otherwise, it can drag on for months. Luna: And the costs — negotiate that the buyer pays if they lose, or split if it's a draw. Lucas: Exactly. And one more thing: the 'earnest money' or 'deposit' that the buyer puts into escrow at signing. That deposit is usually returned to the buyer at closing, but it can also be used to offset any purchase price adjustment. So if the buyer disputes the adjustment, they can hold onto the deposit. Sellers should negotiate that the deposit is released at closing, independent of the adjustment. Luna: So the seller gets their cash, and the adjustment is handled separately. Lucas: Right. Otherwise, you're negotiating under the shadow of the buyer holding your deposit. Luna: This is such a practical episode. I feel like any founder listening should have their SPA open and check Section 2 right now. Lucas: That's the idea. The purchase price adjustment is not a formality — it's the real second negotiation. And the more you understand it, the less likely you are to leave money on the table. Luna: And if you've already sold, maybe you know exactly what we're talking about. Lucas: Yeah. For next time, I want to dig into another underappreciated deal term: the 'covenant' section in credit agreements for leveraged buyouts. There's a lot of hidden leverage there too. Luna: Look forward to it. Until then. Lucas: Take care.