In a competitive M&A bid process, prospective purchasers are often required to enter into a term sheet and formulate an indicative purchase price without having had the opportunity to conduct thorough due diligence on the target business. The purchaser must instead rely on the limited information provided in the seller’s information memorandum or presentation deck. Prudent purchasers will accordingly seek to incorporate scope to adjust their price, either prior to or post entering into the purchase agreement. This article aims to summarise typical price adjustment mechanisms purchasers may seek to incorporate into sale terms, as well as some tips for both parties when formulating and negotiating the purchase price.
The purchase price can comprise cash, shares in the purchaser (also known as ‘scrip’) or a combination of these. Some of the purchase price may be deferred or may be adjusted, retained or released upon certain conditions. The purchase price is commonly offered on a ‘cash-free, debt-free basis assuming a normal level of working capital’. In simple terms this means that the seller keeps all surplus cash and pays out all financial debt in the target group at the time of the sale, but leaving adequate working capital in the business to preserve maintainable earnings at the level that underpinned the offer.
In calculating the purchase price, common valuation techniques include:
Choosing which valuation model to use will be dictated by the type of business being acquired, its asset composition, predictability of cash flows and other factors specific to the purchaser. In many instances, the purchaser’s own valuation is subjective and will have regard to strategic considerations, such as predictions around future market share, growth rates, business cycle conditions, the cost of capital, expenditure and investment in new technology, and control premiums.
In formulating a purchase price, purchasers typically have three adjustment mechanisms available:
The main features of these follow.
Completion accounts are used to confirm whether the actual financial position of the target on the completion date (i.e. the date the purchase price is paid and legal title of the target is transferred from the seller to purchaser) is reflective of the company’s financial position at some agreed point in time, such as the time the term sheet was originally entered into or the date of the most recent audited financial statements. The purchase price is then adjusted up or down depending on the difference between the position in the completion accounts as at completion or at the reference date.
There are generally two adjustment options available – a working capital adjustment or a net asset adjustment. Sometimes a hybrid of both.
In a working capital adjustment, the purchase price will be adjusted so that there are sufficient circulating assets to carry on the business of the target at completion without the need for additional funding from the purchaser. It is most appropriate where the precise value and amount of the fixed assets is either known with a sufficient degree of certainty or is not crucial to the acquisition.
In a net asset adjustment, the purchase price is adjusted by reference to a comprehensive list of assets and liabilities of the target at completion, excluding intangible assets such as goodwill and intellectual property rights. These items have subjective values and should be agreed separately by the parties.
The above adjustments are generally made dollar for dollar and not on a de minimis basis.
Since the seller is typically more familiar with the accounts, they usually prepare them (but not always). Timeframes for preparing the completion accounts vary, however within a month of completion is a rough guide. This is followed by a specified period, often a similar timeframe, for the purchaser to review the accounts. If however the purchaser prepares the accounts, the seller is often required to provide reasonable assistance.
Purchasers need to consider whether they can finance the higher purchase price if an upwards adjustment is required to be made or whether a cap will be applied on the value of specific assets. Parties may also want to consider not adjusting the purchase price at all in circumstances where the working capital or net assets figures fall within a specified range.
The parties should also agree on whether a specific accounting treatment applies. For example, whether such line items as equipment leases are classified as finance leases (and therefore capitalised) or operating leases (and therefore expensed) may differ depending on accounting principles applied. To avoid the apples vs oranges issue, the completion account clause and accounting policies to be applied should be reviewed by the parties’ financial advisers.
Completion accounts are an important protection mechanism for purchasers as they allow the purchaser to review the target’s accounts in the period after the completion date for fluctuations in working capital (or in some cases, the full balance sheet). They are particularly useful if the target is part of a consolidated group or if stand-alone accounts have not previously been prepared. The purchaser can then bring a claim if the final position has changed from the assumed financial position that underpinned the agreed purchase price.
Unlike completion accounts, a locked box is a fixed price mechanism that does not involve a formal review of the target’s financial position on completion. Instead, the target is sold at a fixed price calculated by reference to specified financial accounts made available during the due diligence process, usually audited financial statements to the prior half or full financial year end.
Because the purchase price is fixed, the purchaser will ask that in addition to the usual indemnities and warranties, the seller also indemnify the purchaser for any value that they extract from the target business in the period to completion (known as ‘leakage’). The purchaser will also typically require that the seller give undertakings as to how the business may be conducted between signing and completion. Covenants will include not issuing new securities, varying voting rights, maintaining insurance of key assets, not entering into or varying material contracts, limits on the hiring or rewarding of key staff, commencing material litigation or incurring material capital expenditure.
The seller on the other hand will want to ensure that the definition of ‘value’ when defining leakage is clear, and that it only captures matters that are clearly within the seller’s control and the relevant benefits are actually received by them.
The purchaser customarily allows certain permitted leakages necessary to keep the target operating in the ordinary course of business. This may be extended to agreed pre-sale dividends (to achieve a cash free target) and other agreed amounts.
It is also customary to limit the time for bringing leakage claims to between 3 and 6 months, however purchasers should insist that sellers notify them immediately upon any leakage occurring.
Locked boxes are typically viewed as a seller-friendly mechanism because they give greater certainty regarding the purchase price, with more limited opportunity for the purchaser to make claims after completion.
Subject to warranties, conduct of business undertakings and leakage indemnities, the fluctuations in the value of the business between the reference date and completion are largely at the purchaser’s risk (and reward). Since the purchaser bears the risks and enjoys the upside from conduct of the target business during this period, the purchaser will often conduct a more rigorous financial due diligence to determine the purchase price to be included in the sale agreement.
Earn-outs are mechanisms for allocating between the parties the risk and reward of the target business’ performance post-completion. They can take any form agreed between the parties and are usually structured so that a proportion of the purchase price owing by the purchaser is subject to the achieving certain financial benchmarks within specified time frames (usually 12-36 months).
Earn-outs are often revenue-based, but sometimes profit-based – although, the latter complicates things significantly. However, they can be tailored to any criteria capable of being objectively measured. We have seen such criteria include the winning of key contracts post-completion or obtaining a key licence or accreditation, as well as industry-specific criteria, for instance gross written premium levels as measured criteria for earn-outs in the insurance industry deals.
Both the seller and purchaser. A seller can potentially achieve a higher sale price whilst a purchaser has the comfort of knowing that it will only pay for what it actually buys. However, a party’s gain is often the other’s loss, and vendors are often disappointed at not achieving headline purchase price levels anticipated at the original offer stage by virtue of underperformance of the business after its control has transferred to a purchaser.
Unlike completion accounts or locked box mechanisms, earn-outs are determined by reference to the performance of the target post completion. This means the seller will want contractual assurances in the SPA from the purchaser in terms of how the purchaser operates the business for the duration of the earn-out period. A seller will seek to achieve this by including an ‘operate the business like the sellers did’ covenant, or by setting objective parameters in relation to how the business can be operated and how the purchaser calculates performance incentives. An example might include setting a cap on capital expenditure or ensuring that internal resourcing of the target group remains consistent with historical levels.
A seller must be mindful that such limitations may have the unintended consequence of stifling new ideas and initiatives from management. A private equity investor will typically resist such limitations since they require flexibility in order to transform an acquired business and incentivise management. On this basis, it is uncommon to see financial buyers accept earn-outs with significant vendor protections, instead opting for a clean break to keep the necessary alignment of interests with management.
The parties should further consider:
McCabes specialises in mid-market M&A and has extensive experience advising buyers and sellers across a range of industries. If you are considering buying or selling a business or are otherwise seeking advice on the issues that may arise in relation to such a transaction, please contact the authors Steven Humphries and Danton Stoloff, or other members of McCabes’s Corporate group.
The content of this article is intended to provide a general guide. Specialist advice should be sought having regard to the specific circumstances of your transaction.
In June 2023, a Canadian Court in South-West Terminal Ltd v Achter Land and Cattle Ltd, 2023 SKKB 116, held that the "thumbs-up" emoji carried enough weight to constitute acceptance of contractual terms, analogous to that of a "signature", to establish a legally binding contract. Facts This case involved a contractual dispute between two parties namely South-West Terminal ("SWT"), a grain and crop inputs company; and Achter Land & Cattle Ltd ("ALC"), a farming corporation. SWT sought to purchase several tonnes of flax at a price of $17 per bushel, and in March 2021, Mr Mickleborough, SWT's Farm Marketing Representative, sent a "blast" text message to several sellers indicating this intention. Following this text message, Mr Mickleborough spoke with Mr Achter, owner of ALC, whereby both parties verbally agreed by phone that ALC would supply 86 metric tonnes of flax to SWT at a price of $17 per bushel, in November 2021. After the phone call, Mr Mickleborough applied his ink signature to the contract, took a photo of it on his mobile phone and texted it to Mr Archter with the text message, "please confirm flax contract". Mr Archter responded by texting back a "thumbs-up" emoji, but ultimately did not deliver the 87 metric tonnes of flax as agreed. Issues The parties did not dispute the facts, but rather, "disagreed as to whether there was a formal meeting of the minds" and intention to enter into a legally binding agreement. The primary issue that the Court was tasked with deciding was whether Mr Achter's use of the thumbs-up emoji carried the same weight as a signature to signify acceptance of the terms of the alleged contract. Mr Mickleborough put forward the argument that the emoji sent by Mr Achter conveyed acceptance of the terms of the agreement, however Mr Achter disagreed arguing that his use of the emoji was his way of confirming receipt of the text message. By way of affidavit, Mr Achter stated "I deny that he accepted the thumbs-up emoji as a digital signature of the incomplete contract"; and "I did not have time to review the Flax agreement and merely wanted to indicate that I did receive his text message." Consensus Ad Idem In deciding this issue, the Court needed to determine whether there had been a "formal meeting of the minds". At paragraph , Justice Keene considered the reasonable bystander test: " The court is to look at “how each party’s conduct would appear to a reasonable person in the position of the other party” (Aga at para 35). The test for agreement to a contract for legal purposes is whether the parties have indicated to the outside world, in the form of the objective reasonable bystander, their intention to contract and the terms of such contract (Aga at para 36). The question is not what the parties subjectively had in mind, but rather whether their conduct was such that a reasonable person would conclude that they had intended to be bound (Aga at para 37)." Justice Keene considered several factors including: The nature of the business relationship, notably that Mr Achter had a long-standing business relationship with SWT going back to at least 2015 when Mr Mickleborough started with SWT; and The consistency in the manner by which the parties conducted their business by way of verbal conversation either in person or over the phone to come to an agreement on price and volume of grain, which would be followed by Mr Mickleborough drafting a contract and sending it to Mr Achter. Mr Mickleborough stated, "I have done approximately fifteen to twenty contracts with Achter"; and The fact that the parties had both clearly understood responses by Mr Achter such as "looks good", "ok" or "yup" to mean confirmation of the contract and "not a mere acknowledgment of the receipt of the contract" by Mr Achter. Judgment At paragraph , Keene J said: "I am satisfied on the balance of probabilities that Chris okayed or approved the contract just like he had done before except this time he used a thumbs-up emoji. In my opinion, when considering all of the circumstances that meant approval of the flax contract and not simply that he had received the contract and was going to think about it. In my view a reasonable bystander knowing all of the background would come to the objective understanding that the parties had reached consensus ad item – a meeting of the minds – just like they had done on numerous other occasions." The court satisfied that the use of the thumbs-up emoji paralleled the prior abbreviated texts that the parties had used to confirm agreement ("looks good", "yup" and "ok"). This approach had become the established way the parties conducted their business relationship. Significance of the Thumbs-Up Emoji Justice Keene acknowledged the significance of a thumbs-up emoji as something analogous to a signature at paragraph : "This court readily acknowledges that a thumbs-up emoji is a non-traditional means to "sign" a document but nevertheless under these circumstances this was a valid way to convey the two purposes of a "signature" – to identify the signator… and… to convey Achter's acceptance of the flax contract." In support of this, Justice Keene cited the dictionary.com definition of the thumbs-up emoji: "used to express assent, approval or encouragement in digital communications, especially in western cultures", confirming that the thumbs-up emoji is an "action in an electronic form" that can be used to allow express acceptance as contemplated under the Canadian Electronic Information and Documents Act 2000. Justice Keene dismissed the concerns raised by the defence that accepting the thumbs up emoji as a sign of agreement would "open the flood gates" to new interpretations of other emojis, such as the 'fist bump' and 'handshake'. Significantly, the Court held, "I agree this case is novel (at least in Skatchewan), but nevertheless this Court cannot (nor should it) attempt to stem the tide of technology and common usage." Ultimately the Court found in favour of SWT, holding that there was a valid contract between the parties and that the defendant breached by failing to deliver the flax. Keene J made a judgment against ALC for damages in the amount of $82,200.21 payable to SWT plus interest. What does this mean for Australia? This is a Canadian decision meaning that it is not precedent in Australia. However, an Australian court is well within its rights to consider this judgment when dealing with matters that come before it with similar circumstances. This judgment is a reminder that the common law of contract has and will continue to evolve to meet the everchanging realities and challenges of our day-to-day lives. As time has progressed, we have seen the courts transition from sole acceptance of the traditional "wet ink" signature, to electronic signatures. Electronic signatures are legally recognised in Australia and are provided for by the Electronic Transactions Act 1999 and the Electronic Transactions Regulations 2020. Companies are also now able to execute certain documents via electronic means under s 127 of the Corporations Act. We have also seen the rise of electronic platforms such as "DocuSign" used in commercial relationships to facilitate the efficient signing of contracts. Furthermore, this case highlights how courts will interpret the element of "intention" when determining whether a valid contract has been formed, confirming the long-standing principle that it is to be assessed objectively from the perspective of a reasonable and objective bystander who is aware of all the relevant facts. Overall, this is an interesting development for parties engaging in commerce via electronic means and an important reminder to all to be conscious of the fact that contracts have the potential to be agreed to by use of an emoji in today's digital age.
The McCabes Government team are pleased to have assisted Venues NSW in successfully overturning a District Court decision holding it liable in negligence for injuries sustained by a patron who slipped and fell down a set of steps at a sports stadium; Venues NSW v Kane  NSWCA 192 Principles The NSW Court of Appeal has reaffirmed the principles regarding the interpretation of the matters to be considered under sections5B of the Civil Liability Act 2002 (NSW). There is no obligation in negligence for an occupier to ensure that handrails are applied to all sets of steps in its premises. An occupier will not automatically be liable in negligence if its premises are not compliant with the Building Code of Australia (BCA). Background The plaintiff commenced proceedings in the District Court of NSW against Venues NSW (VNSW) alleging she suffered injuries when she fell down a set of steps at McDonald Jones Stadium in Newcastle on 6 July 2019. The plaintiff attended the Stadium with her husband and friend to watch an NRL rugby league match. It was raining heavily on the day. The plaintiff alleged she slipped and fell while descending a stepped aisle which comprised of concrete steps between rows of seating. The plaintiff sued VNSW in negligence alleging the stepped aisle constituted a "stairwell" under the BCA and therefore ought to have had a handrail. The plaintiff also alleged that the chamfered edge of the steps exceeded the allowed tolerance of 5mm. The Decision at Trial In finding in favour of the plaintiff, Norton DCJ found that: the steps constituted a "stairwell" and therefore were in breach of the BCA due to the absence of a handrail and the presence of a chamfered edge exceeding 5mm in length. even if handrails were not required, the use of them would have been good and reasonable practice given the stadium was open during periods of darkness, inclement weather, and used by a persons of varying levels of physical agility. VNSW ought to have arranged a risk assessment of the entire stadium, particularly the areas which provided access along stepped surfaces. installation of a handrail (or building stairs with the required chamfered edge) would not impose a serious burden on VNSW, even if required on other similar steps. Issues on Appeal VNSW appealed the decision of Norton DCJ. The primary challenge was to the trial judge's finding that VNSW was in breach of its duty of care in failing to install a handrail. In addition, VNSW challenged the findings that the steps met the definition of a 'stairwell' under the BCA as well as the trial judge's assessment of damages. Decision on Appeal The Court of Appeal found that primary judge's finding of breach of duty on the part of VNSW could not stand for multiple reasons, including that it proceeded on an erroneous construction of s5B of the Civil Liability Act 2002 and the obvious nature of the danger presented by the steps. As to the determination of breach of duty, the Court stressed that the trial judge was wrong to proceed on the basis that the Court simply has regard to each of the seven matters raised in ss 5B and 5C of the CLA and then express a conclusion as to breach. Instead, the Court emphasised that s 5B(1)(c) is a gateway, such that a plaintiff who fails to satisfy that provision cannot succeed, with the matters raised in s 5B(2) being mandatory considerations to be borne in mind when determining s 5B(1)(c). Ultimately, regarding the primary question of breach of duty, the Court found that: The stadium contained hazards which were utterly familiar and obvious to any spectator, namely, steps which needed to be navigated to get to and to leave from the tiered seating. While the trial judge considered the mandatory requirements required by s5B(2) of the CLA, those matters are not exhaustive and the trial judge failed to pay proper to attention to the fact that: the stadium had been certified as BCA compliant eight years before the incident; there was no evidence of previous falls resulting in injury despite the stairs being used by millions of spectators over the previous eight years; and the horizontal surfaces of the steps were highly slip resistant when wet. In light of the above, the Court of Appeal did not accept a reasonable person in the position of VNSW would not have installed a handrail along the stepped aisle. The burden of taking the complained of precautions includes to address similar risks of harm throughout the stadium, i.e. installing handrails on the other stepped aisles. This was a mandatory consideration under s5C(a) which was not properly taken into account. As to the question of BCA compliance, the Court of Appeal did not consider it necessary to make a firm conclusion of this issue given it did not find a breach of duty. The Court did however indicated it did not consider the stepped aisle would constitute a "stairway" under the BCA. The Court of Appeal also found that there was nothing in the trial judge's reasons explicitly connecting the risk assessment she considered VNSW ought to have carried out, with the installation of handrails on any of the aisles in the stadium and therefore could not lead to any findings regarding breach or causation. As to quantum, the Court of Appeal accepted that the trial judge erred in awarding the plaintiff a "buffer" of $10,000 for past economic loss in circumstances where there was no evidence of any loss of income. The Court of Appeal set aside the orders of the District Court and entered judgment for VNSW with costs. Why this case is important? The case confirms there is no obligation in negligence for owners and operators of public or private venues in NSW to have a handrail on every set of steps. It is also a welcome affirmation of the principles surrounding the assessment of breach of duty under s 5B and s 5C of the CLA, particularly in assessing whether precautions are required to be taken in response to hazards which are familiar and obvious to a reasonable person.
The recent decision in New Aim Pty Ltd v Leung  FCAFC 67 (New Aim) has provided some useful guidance in relation to briefing experts in litigation.