How do you avoid post-closing disputes over working capital adjustments?

Defining terms in a purchase agreement, such as working capital, helps prevent post-closing disputes. Clarify components, exclusions, accounting standards, reference date, target amount, and adjustment mechanisms. This minimizes ambiguity and misinterpretation. Additionally, consider addressing dispute resolution procedures and any special considerations unique to the transaction, reinforcing transparency and alignment between parties.

Defining the working capital items would require a detailed due-diligence and the experts in this area (financial due diligence experts rather than the pure accounting expertise). The formulation and definitions should be stated in detail in the deal documents.

To completely eliminate disputes around working capital later in the process, start early. Make sure you're addressing it in your CIM (30-50 page overview of your business), and including it as an expectation of your EOI & LOI when you receive them so you can confirm alignment early and address any differences of opinions. If you've got a good business, are reasonable with your expectations, and proposing fair terms - you can completely eliminate the risk of a dispute or last-minute re-trade.

Working capital is one of the most common discussion points in a negotiation. Define what is actual 'operating working capital' versus pure accounting working capital. If inventory is involved, then some form of working capital peg needs to be established, and the method agreed.

If you have clearly communicated and agreed on the way working capital is calculated, then due diligence should be confirmatory in nature.

Thorough due diligence on a target company's financials, accounting, and working capital is crucial to mitigate post-closing disputes. Scrutinizing aspects like revenue recognition, inventory valuation, and contingencies ensures accurate valuation and offer adjustments. Additionally, assessing operational efficiencies and market trends provides a comprehensive understanding, safeguarding against unforeseen challenges. Diligent scrutiny not only validates seller-provided information but also fosters transparency and trust, laying a robust foundation for successful transactions.

In the German SME market, during the due diligence process, I request a "list of planned actions" from the seller side. In this closing list, I ask the seller to specify the actions planned till the company is finally handed over. This approach has many advantages. First, the seller side is forced to think through the actions carefully. Second, sometimes new price relevant information is revealed, as the incumbent often plans to sell non-operating assets (e.g. the owner's car) to itself before the transaction takes place. Finally, when new information outside the list emerge, the buyer side can easily refer to the list and renegotiate.

Build in an option to extend the due diligence period in the event a discrepancy arises and there isn't enough time to fully resolve the issue before DD expires. Even if you have to put additional money down towards the deposit, it's better to have these issues identified during due diligence period than in a post-closing dispute.

The combination of a seasoned M&A advisor and a lawyer is very effective. Both should have an idea of what "is market" and be able to push buyers back for unreasonable claims. Just make sure that your M&A advisors are doing their homework on your numbers to make sure they can back up their claims with the raw date when asked during due diligence.

During speeches, I usually state "the price is negotiated twice". Later, I like to detail that in transactions in the German SME market, you often agree on the "contract price" and the "way to determine the final contract price" at two different occasions. Knowing this upfront, prevents many potentially complicated and emotional situations so that I communicate this to my clients early on during the process.

In the German SME market, a good connection between seller and buyer after the transaction is very important due to a high degree of firm-specific knowledge and information. To avoid a harmful escalation early after the transaction, I therefore like to negotiate liberal exemption limits and thresholds to ensure that escalation takes places only on meaningful issues.