Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Post-Closing Adjustment That Cost a Seller 35 Million
Transcript
- Lucas: So, a hundred and sixty episodes in, we've talked a lot about the traps that cost people money before the deal closes. But today, I want to dig into one that comes after — the post-closing adjustment. And I've got a case that's going to make you wince. Luna: I love a good wince. What are we looking at? Lucas: So picture this: a manufacturing company, call it Acme Components, gets sold for two hundred million dollars. The deal closes in June, everyone's happy. Then, ninety days later, the buyer comes back with a working capital adjustment that claws back thirty-five million. The seller is stunned. They thought they'd done everything right. Luna: Thirty-five million on a two hundred million deal — that's significant. How did the buyer justify it? Lucas: The purchase agreement had a standard working capital peg, set at the average of the last twelve months. But the definition of 'working capital' was vague — it said 'current assets minus current liabilities, in the ordinary course of business.' The problem? The buyer's accountants decided that a big customer prepayment — twenty million dollars — wasn't 'ordinary course' because it was a one-off, so they excluded it from working capital, which reduced the amount the seller got. Luna: So the buyer essentially reinterpreted 'ordinary course' to mean 'recurring'? That seems like a stretch. Lucas: Exactly. And that's the trap. The seller thought 'ordinary course' meant 'in line with how we normally operate,' but the buyer interpreted it as 'consistent with historical levels.' The prepayment was a legitimate business move — a customer paid early for a bulk order — but because it was unusual, the buyer argued it shouldn't count. And the language didn't specify, so it went to arbitration. Luna: And arbitration didn't go the seller's way, I'm guessing. Lucas: Right. The arbitrator sided with the buyer, saying that 'ordinary course' in the context of working capital should reflect typical operations, not one-off events. So the seller lost thirty-five million. But here's the thing — this could have been avoided with better drafting. Luna: I think this is a good moment to mention something. We're able to do these deep dives because of listeners who chip in a couple of dollars a month on Buy Me a Coffee. If you've gotten something out of these episodes, that's genuinely what keeps them going — and it keeps everything ad-free. Lucas: Yeah, we don't have sponsors, so it's really listener-supported. Even a small contribution makes a real difference — it covers hosting, research, all that. And we're back to the working capital trap in a second, but I want to be clear, we're not asking for a lot. Just a few bucks if you can swing it. Luna: And we're grateful for every single one. Now, back to the case — so how could the seller have protected themselves? Lucas: Well, for starters, they should have defined 'ordinary course' explicitly in the agreement. For example, you could say 'ordinary course means consistent with the company's past practice, including non-recurring items that are consistent with the business's historical volatility.' That would cover a prepayment like that. Luna: But that still leaves room for interpretation, right? How do you pin it down more? Lucas: You could attach a schedule of what counts as working capital — specific line items, with examples of what's included and what's excluded. And you might even set a threshold for unusual items, like anything over five million gets flagged for mutual agreement before closing. Luna: That seems sensible. But what if the buyer still tries to pull something? Lucas: Then you have the dispute resolution process. In this case, they had an independent accountant — but the contract said the accountant's decision was final and binding. The seller's mistake was not specifying that the accountant had to follow the agreed-upon definitions. They just said 'resolve any disputes,' which left it open to interpretation. Luna: So the seller should have also locked down the rules of engagement for the accountant. Lucas: Exactly. You want to say 'the accountant shall apply the definitions in this agreement, and any ambiguity shall be resolved in accordance with the seller's historical accounting practices.' That gives the accountant a clear directive. Luna: I imagine there's also the question of timing. How long after closing can the buyer raise these issues? Lucas: Typically, the post-closing adjustment period is sixty to ninety days. But in this case, the buyer flagged the prepayment within the window, so it was valid. However, the seller could have negotiated a cap on adjustments — like, the adjustment can't exceed ten percent of the purchase price. That would have capped the damage at twenty million instead of thirty-five. Luna: That's a good point. A cap gives you downside protection. Lucas: Right. And the seller could have also required that the buyer provide a detailed, itemized spreadsheet with supporting documents for any proposed adjustment, and a deadline for raising issues beyond which they're waived. That forces the buyer to be transparent. Luna: So, what's the takeaway for a seller going into a deal? What do they need to focus on? Lucas: I'd say the golden rule is: don't rely on generic language. If you want to protect yourself, you have to be specific. Define every term that could be ambiguous, attach schedules, set caps, and control the dispute process. It's not the most exciting part of M&A, but it's where the real money can be lost. Luna: And it's not just about the seller. Buyers can get hurt too, right? If the definitions are sloppy, they might overpay. Lucas: Absolutely. A buyer who inherits a vague working capital definition might end up with less working capital than they thought, which affects their own cash flow. So both sides have a stake in getting this right. Luna: So this is one of those rare cases where clarity benefits everyone. Lucas: Exactly. And that's the thing — a well-drafted working capital mechanism shouldn't be a source of conflict. It should be a straightforward process for adjusting the purchase price based on the actual state of the business at closing. But when it's vague, it becomes a battleground. Luna: I've also heard of deals where the working capital target is set as a range, not a single number. Does that help? Lucas: It can. A range gives you some flexibility. For example, if the target net working capital is fifty million, you could say 'the adjustment is zero if the closing working capital is between forty-five and fifty-five million.' That way, minor fluctuations don't trigger a dispute. But if the buyer expects a specific number, they might push back. Luna: So it's all a negotiation. What's your advice for a seller who's already in the middle of a dispute like this? Lucas: First, don't panic. Get your own accounting team and legal counsel to review the buyer's claim line by line. Sometimes buyers throw in dubious items hoping you'll concede. In this case, the seller could have challenged the prepayment exclusion, but they didn't have strong enough language to back them up. Luna: So the negotiation starts even before the deal closes. You have to fight for the right language. Lucas: Absolutely. And that's the lesson from this episode: every word in that purchase agreement is a potential million-dollar decision. Don't leave it to chance. Luna: Well, I think we've given our listeners a lot to think about. And if you're in the middle of a deal, maybe take another look at your working capital definitions. Lucas: And if you have a story like this, we'd love to hear from you. But for now, thanks for listening, and we'll catch you next time on The Acquisition Talk.