For some time, uncertainty has been the prevailing feature of the UK business landscape but despite this, M&A activity has remained reasonably strong. Pulled along by favourable exchange rate movements and acceptance that some form of uncertainty is probably here to stay, demand for sale and purchase agreement (SPA) reviews has increased.
Conducting a thorough review of these agreements prior to completion is essential in order to identify any potential problem areas in good time, and ensure the transaction is completed smoothly. So what are the most common sources of disputes relating to SPAs and how can they be avoided?
Between the point of parties agreeing the terms of a share transaction and the completion of the deal, there is a transitory period in which the seller retains control of the business, but the risks and rewards of ownership fall substantially upon the buyer. This situation isn’t helped by the fact that the accounts or financial statements that have featured prominently in the deal and decision-making process, will become increasingly dated.
Most SPAs use a number of features to address this issue, including price-adjustment mechanisms, earn out provisions and warranties. However, particular attention is required when drawing up these elements to minimise the risk of disputes arising.
Whatever terms are put in place in a share transaction, it is likely that there will be a need to provide the buyer with updated financial information upon completion. In this respect, the SPA should be clear about who is responsible for preparing this information (usually the buyer as relevant information will only become available post-completion), the timetable for preparation and also for setting out any challenge to the financial position advanced, together with the accounting approach and conventions that are to be applied.
It is critical that the SPA defines exactly which accounting standards, policies and practices should be followed as tension can arise where the parties are able to form conflicting interpretations or if different accounting standards allow conflicting approaches. This is especially important for more subjective areas such as accounting estimates and provisions.
Businesses may even wish to set out an order of preference distinguishing between historic or usual practice and the strict application of accounting standards. Similarly, providing exact sums or clear details of how to calculate figures such as bad debt or stock provisions, and specifying the accounting approach that should prevail for other balances is key in preventing ambiguity that could result in a post-completion claim.
When drawing up an SPA, it is also important to be specific about the materiality that should be applied to any closing or final financial accounts. While this is often stated as zero at the point of completion, accounting conventions and practices used for underlying management or audited accounts will, for practical reasons, allow for a materiality level. As such, a materiality or de minimis claim level should be set out clearly to avoid any potential issues arising from this disparity.
Earn outs based on pre-agreed KPIs are often incorporated within SPAs as a means of incentivising sellers and key management to stay focused on running the business and optimising its value, before and after completion. As these are usually dependent upon the results achieved by the target business and involve spreading the payment of consideration over an extended period, they may represent an incentive to manipulate reported results.
With this in mind, a robust SPA should afford protection from potential opportunities to exploit post completion reported results or otherwise extract value from the business. We have seen significant investment in areas such as marketing, people or equipment or the accelerated writing-off of assets used to depress current results and yield a higher return in future periods.
Experienced forensic accountants will most likely have dealt with fallout from all of the issues above, and will be able to provide buyers and sellers with proactive advice at an early stage, preventing potential issues arising upon completion of the deal. By ensuring SPAs are drafted correctly first time around and tailored to the particular circumstances of both the business and the transaction, businesses will be well placed to avoid potential disputes and realise their commercial objectives.