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Trends in M&A: Post-Closing Purchase Price Adjustments and Indemnification Claims

By: Patrick Keating, Attorney at Law

A recent study published by SRS Acquiom focused on purchase price adjustments and indemnification claims based on an analysis of 574 private-target transactions that took place during the period from Q3 2018 through Q3 2020.

The following are some important highlights from the report:

Purchase Price Adjustments:
  • 79% of the transactions which included a Purchase Price Adjustment mechanism ended up having some type of adjustment to the purchase price post-closing.
  • 50% of the transactions which included a Purchase Price Adjustment mechanism had a buyer-favorable claim for an adjustment.
These numbers show the importance of negotiating Purchase Price Adjustment provisions and understanding the post-closing effect these provisions can have on both sides of a transaction. It is important to determine how the target company is accounting for its operations at the time of closing in order to establish an accurate closing number and post-closing Purchase Price Adjustment formula. This will provide for the least amount of deviation from the closing numbers and decrease the risk for any future disputes or possible litigation when the final numbers are determined after the true-up period. Further, it is critical to establish Purchase Price Adjustment procedures to account for any potential disputes between the parties on potential adjustments.

Indemnification Claims
  • Indemnification claims were made in 38% of all transactions analyzed (excluding claims related to Purchase Price Adjustments).
  • Claims for fraud are the largest category by dollar amount for which indemnification claims are made and is the only category of indemnification claims in which the median claim amount exceeds the size of the escrow amount for such transactions, if any.
  • Other types of claims did exceed the escrow amount in certain instances, but typically, non-fraud claims were much smaller than the amount of escrow for the transaction.
  • Public companies who were buyers and sophisticated financial buyers made the most claims against parties to the transaction. However, the dollar amount of the claims made by public buyers is lower than other buyer categories.
  • Claims in transactions that include representation and warranty insurance are similar in both size and frequency to all transactions.
  • The size of claims for undisclosed liabilities and relating to financial statements have remained high in recent years and often combined with claims for fraud.
Given the frequency of claims for indemnification (38% of the time), it is vital to provide for the appropriate post-closing protections and procedures for both sides of the transaction. For sellers, it is important to understand where the potential indemnification claims may come from and to analyze and understand the potential financial liability associated with such claims in the event they occur. This is discovered during the legal and financial due diligence performed prior to—and leading up—to the closing of the transaction. This will help both sides understand whether an escrow hold-back is necessary or desired to account for such potential future liability. Further, it is important for sellers to negotiate the appropriate survival periods, baskets, and caps to be included in the indemnification provisions in order to minimize potential liability as much as possible.

For buyers, this information shows the ongoing importance for including comprehensive representations and warranties regarding the target company as well as establishing the appropriate procedures for post-closing indemnification claims. Further, it is important to uncover and understand any specific areas for potential future liability during the due diligence period in order to provide indemnification for specific items as needed and to make sure the necessary indemnification claims are not subject to any limitations, such as baskets and caps or survival periods.

It is easy to see the importance of navigating these specific provisions in a merger or acquisition transaction, which can be a difficult and detailed process. However, taking the time and energy to put the necessary provisions in place prior to closing can help both buyers and sellers to prevent future liability and disputes.

Patrick Keating is an attorney in the Business Services group at Carmody MacDonald in St. Louis. He focuses his practice on mergers and acquisitions, corporate governance, and business law. Contact Patrick at pwk@carmodymacdonald.com or 314-854-8668.

This column is for informational purposes only. Nothing herein should be treated as legal advice or as creating an attorney-client relationship. The choice of a lawyer is an important decision and should not be based solely on advertisements.