Purchase Price, in the context of an acquisition, is not as simple as it might otherwise sound. To arrive at the Purchase Price for a target company the parties involved must first agree on the value of the company. This value is often defined in a stock purchase agreement as Base Purchase Price or Initial Purchase Price.
Using Base Purchase Price for purposes of this example, a series of adjustments must typically be made to arrive at the Purchase Price. This is largely because most transactions are contemplated on a cash-free, debt-free basis and assuming an appropriate level of net working capital at the closing, and it may be impossible to accurately measure net working capital on or prior to the closing date of the transaction.
Consequently, to arrive at the Purchase Price, the Base Purchase Price will need to be adjusted for the following:
- the amount of cash on the balance sheet;
- net working capital; and
- transaction expenses.
Items (1) and (2) above adjust the Base Purchase price for a cash-free, debt-free transaction. This means that the Seller is entitled to the cash on the balance sheet on the closing date of the transaction, and that the Seller is responsible for debts owed by the company (defined as Indebtedness). Item (3) is addressed in a post titled “The Working Capital Adjustment.” And item (4) is included to ensure that the Seller is responsible for the fees and expenses associated with the transaction that are incurred by the target company and/or the Seller.
In summary, the Purchase Price will be calculated as follows:
- the Base Purchase Price;
- plus Cash;
- minus Indebtedness;
- plus the amount, if any, by which Net Working Capital is greater than the Net Working Capital Target;
- minus the amount, if any, by which Net Working Capital is less than the Net Working Capital Target;
- minus the Transaction Expenses.
In a stock purchase agreement all of the capitalized words in the bullets above require definitions. The definition for Indebtedness frequently covers half a page or more (we have included an abbreviated definition).
If you are interested in learning more about this in the context of a purchase agreement, please see the mini course titled Stock Purchase Agreement available as part the the ASM+ PRO tier.