Before discussing some potential areas of disagreement, we need to address several foundational issues that permeate the basis for disputes. By recognizing these issues during the diligence and document review, the more likely a dispute can be averted or minimized.
On the top of the list is measurement. Understanding, and by understanding, I mean documenting, the agreements with guidance on how an item or items will be valued is critical. This is particularly relevant for items that involve judgement such as reserves, allowances, and contingencies. The measurement of value can vary widely depending on the application of specific measurement principles. The most common measurement standards include Generally Accepted Accounting Principles (GAAP), International Financial Reporting Standards (IFRS) and GAAP as historically applied by the seller.
Understanding of measurement goes beyond documentation of the deal, it can and should include models of different outcomes and discussions of their expectations by the buyer and seller.
Measurement is not limited to the value of the entire company. How something will be measured has to take into account all facets of what it is that is being measured (is it the total business value or that portion of the business that is most concerning to the buyer – like a high growth subsidiary with limited historic data). Critically, the measurement calculation and methodology need to be agreed to, as well as the time period being measured and the attributes of shared expenses.
Measurement will extend to the post-closing period. The seller needs to be concerned with the discretionary guardrails in operating the business during the post-closing period of measurement. The buyer needs to have discretion to operate the business but cannot take actions to the detriment of the seller in the post-closing measurement of value metrics.
Second on the list, and it goes hand in hand with measurement, is the insertion of overly complex calculations. This, coupled with vague, ambiguous language, or maybe no language at all, can lead to disagreements. Similarly modeling of outcomes, examples of the calculations with plain language explanations based on communication during due diligence will minimize the disagreements.
Cutoff dates for measurement or closing can also wreak havoc on the ability to measure outcomes. Accounting systems are built around a month-end close. Choosing a mid-month close can complicate normal measurement methods and processes. Something as simple as a prepaid expense becomes complicated by trying to determine who is deriving the benefit. Similarly, choosing a closing or measurement too close to major pending business transactions or an impending or terminating contract can create measurement nightmares.
Finally on our list of biggest contributors to disagreement, is incomplete due diligence. Incomplete diligence leads directly to a misunderstanding of the value given up and the value attained. There can be several potential reasons, including missing documentation, a distressed target, or impending legal or regulatory action. These reasons as well as others resulting from a lack of candor or deliberate omission by the seller or incomplete due diligence by the buyer can lead to significant disagreement on the ultimate value.
In our third installment we’ll start our look at some of the specific areas of disagreement.
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For more information on this topic, please contact a member of Withum’s Forensic and Valuation Services Team.
