Purchase Price in a Stock Purchase Agreement
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 will then be defined in the definitions of a stock purchase agreement as something similar to Base Purchase Price or Initial Purchase Price.
Using Base Purchase Price for the purposes of this example, a series of adjustments must then typically be made to arrive at Purchase Price. This is largely because most transactions are contemplated on a cash-free, debt-free basis, and because it is impossible to accurately measure net working capital in advance of or on the date of the transaction.
Consequently, to arrive at Purchase Price the Base Purchase Price needs to be adjusted for the following:
- the amount of cash on the balance sheet;
- indebtedness (to be defined later in this post);
- 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 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 in a Purchase Agreement
. And item (4) is included to make sure that the Buyer is responsible for the fees and expenses associated with the transaction.
In summary, to arrive at Purchase Price the following adjustment are made:
- the Base Purchase Price;
- plus Cash;
- minus Indebtedness;
- plus the amount by which Net Working Capital is greater than the Net Working Capital Target;
- minus the amount by which Net Working Capital is less than the Net Working Capital Target;
- minus the Transaction Expenses.
In a 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). To visualize how the definitions and the calculation of purchase price come together we have included a summarized example on the pages that follow.
Stock Purchase Agreement Language:
The download associated with this post contains hypothetical language detailing the above sequence as it might appear in a stock purchase agreement. Download PDF File.