LEGAL ADVICE
Study gives inside look at trends
in mergers and acquisitions
T
he purchase and sale of businesses
are a key part of the U.S. economy
and a common method by which
business owners realize the value of their
entrepreneurial efforts. Although every
sale transaction is different, deals often
contain similar legal structures and provi-
sions.
A helpful resource regarding current
marketplace terms is prepared every
few years by the Mergers & Acquisitions
Committee of the American Bar Associa-
tion. The recently released 2009 Private
Target Mergers & Acquisitions Deal Points
Study analyzes 106 publicly reported M&A
transactions that range from $25 million
to $500 million. Even for business sales of
less than $25 million, the study provides a
useful benchmark of what terms and con-
ditions in an acquisition agreement may
be considered “market.”
In any acquisition, there are generally
four main parts to the definitive agree-
ment: a description of the purchase price
and terms related to what is purchased;
closing conditions; representations and
warranties of the seller regarding the tar-
get’s business; and indemnification obliga-
tions of the seller after closing. While the
study analyzes many provisions and trends
in acquisition agreements since 2004, we
will highlight the provisions described in
the study that relate to: (1) adjustments
to the cash purchase price received by the
seller; and (2) what portion of the pur-
chase price is subject to claims made by
the buyer or third parties.
Adjustments to cash
received at closing
For the seller, the most important
term of any business sale is usually the
purchase price, and the most important
part of the purchase price is usually the
cash received at the closing. Two common
terms of deals that directly affect the cash
received at or shortly after closing are
post-closing purchase price adjustments
and holdback escrows.
Purchase price adjustments start with
the idea that the business will have an
 Capital Region Business Journal | March 2010
Rochelle H. Klaskin
and Paul J. Karch
are shareholders and members of Godfrey &
Kahn’s Corporate Practice Group. For more
information, Rochelle can be reached at 608-
284-2607 or rklaskin@gklaw.com. Paul can be
reached at 608-284-2252 or pkarch@gklaw.com.
adequate amount of working capital at the
closing but that the various elements of
working capital will vary from day to day
in the normal operation of the business.
To account for those variations, and to
remove any incentive of the seller to drain
the working capital prior to closing, an
increasing majority of deals (79 percent in
2009, up from 68 percent in 2006) include
a post-closing purchase price adjustment
for variations in working capital and
sometimes other assets or liabilities such
as specified debt.
Most of the time, an estimated working
capital number is calculated by the seller
and a payment based on that number is
made at closing. Then, the buyer prepares
a post-closing balance sheet. After some
sort of approval and dispute resolution
process, the closing balance sheet is con-
firmed, and the buyer or seller “trues up”
the difference between the estimate and
the final number. In some recent deals, we
have seen buyers and sellers differ on the
calculation of working capital. One good
way to reduce the risk of differing inter-
pretations is to have a sample calculation
based on a prior balance sheet incorpo-
rated into the agreement and adjustment
process.
About 80 percent of deals include an
escrow or holdback from the cash paid at
closing to back up the seller’s indemnity
obligations or to fund any buyer obliga-
tion for a working capital adjustment. The
median amount of holdbacks was about 10
percent of transaction value. The amount
of the holdback is important but the
indemnity terms that determine how and
how much of the holdback can be claimed
by the buyer should be the primary focus
of the seller.
Later claims of buyer or others
Indemnification obligations of the seller
can arise from several factors but in large
part come from obligations related to
non-assumed liabilities by the buyer and
breaches of representations and war-
ranties by the seller. For example, if the
seller represents that all of its inventory
is in good and saleable condition and it
turns out that 25 percent of the inven-
tory is obsolete, then the buyer will likely
have an indemnification claim against the
seller. Sellers can limit their indemnifica-
tion obligations after the sale in two main
ways. First, the agreement can establish an
overall indemnification cap; and second,
the buyer and seller can establish what is
called a “basket.”
An indemnification cap limits the
overall liability of the seller after the clos-
ing, and 92 percent of the deals analyzed
included a cap. Of those transactions,
the cap equaled the transaction price
in 4 percent of the deals (down from 7
percent in 2006 and 14 percent in 2004),
and the transaction caps were less than
the purchase price in 86 percent of the
transactions (as compared to 88 percent in
2006 and 74 percent in 2004). The mean
cap was 21.72 percent and the median cap
was 11.19 percent of the transaction value.
However, even when agreements include
caps, the agreement will also exclude some
claims that are not subject to the cap,
such as fraud and the breach of certain
key covenants. Generally, caps will be a
smaller percentage when the purchase
price is larger. Given the buyers’ market in
2008 and 2009, indemnification caps have
trended upward.
Another way to limit liability for the
seller is to establish a “basket.” When a
basket is established, a buyer may not percent included a First Dollar basket and 2 percent of the transaction value.
recover any losses under an indemnifica- 12 percent included a combination deduct- Every M&A transaction is unique, but
tion provision until the total losses exceed ible/First Dollar basket. These percentages there are common terms in those deals
a certain threshold. that are influenced by
This threshold is the market practices and
basket. The basket can In any acquisition, there are generally four main trends. Merger and
be either a “dollar-one” acquisition lawyers,
or “first-dollar” basket
or act as a deductible.
parts to the definitive agreement: a description investment bank-
ers, and others often
When the basket is argue in favor of or
a deductible basket, of the purchase price and terms related to what against particular
a seller only has to terms based on the
indemnify the buyer for
losses that exceed the
is purchased; closing conditions; representations “market” for those
terms. Deal experi-
threshold established
for the basket. In a and warranties of the seller regarding the target’s ence and understand-
ing the data in the
First Dollar basket, ABA Deal Points
once the losses exceed business; and indemnification obligations of the Study helps to assess
the threshold, the seller the reality of those
is responsible for the
losses that “filled up”
seller after closing. arguments. Common
understandings of
the basket as well as market terms can
those that exceeded bring efficiency and
the basket. Only 5 percent of deals did have remained generally the same for fairness to the process so that buyers and
NOT include a basket, while 47 percent of transaction since 2004. The value of the sellers may more easily reach their true
the deals included a deductible basket, 36 basket generally ranged from .5 percent to objective: closing the deal. n

Capital Region Business Journal | March 2010