How to Handle M&A Breaches
An M&A purchase agreement that doesn’t lay out the process of adjudicating a disagreement is almost certainly inviting problems. Breaches (in other words, post-closing disputes between Buyer and Seller), come in three basic flavors: violation of noncompete and non-solicitation agreements, discrepancies with working capital, and breaches of reps and warranties.
M&A violations of the noncompete and non-solicitation agreements
One of the biggest concerns a Buyer has is that the Seller will take the money from the sale and open a competing business across the street, perhaps even hiring (or attempting to hire) employees now working for the Buyer.
Because of these concerns, most purchase agreements contain noncompete agreements preventing Seller from opening a competing business in a certain defined geographic area for a certain defined amount of time, as well as non-solicitation agreements barring Seller from hiring or trying to hire Buyer’s employees.
If you as a Buyer suspect a breach of these agreements, speak with your attorney. The typical course of action in these cases may include going to court and obtaining a temporary restraining order.
Sellers, don’t forget that Buyers effectively derive a portion of the purchase price from the noncompete agreement. Essentially, Buyer is paying you not to compete, so breaching this agreement may affect your valuation.
M&A discrepancies with working capital
M&A parties make adjustments to the purchase price a few weeks after closing, after the Buyer has an updated balance sheet for closing day. Sometimes, this balance sheet can be a source of disagreement between Buyer and Seller because the Buyer’s calculations don’t match what the Seller promised.
In particular, working capital (the difference between quickly convertible assets, such as accounts receivable and inventory, and the bills that are due within 30 days, such as accounts payable) commonly creates disputes.
Some typical areas of dispute between Buyer and Seller include
Bad debts reserve: Buyer may claim Seller didn’t set aside a sufficient reserve against bad debts. In other words, the value of the accounts receivable wasn’t as high as Seller claimed at closing.
Inventory valuation: Buyer may claim Seller overvalued inventory and/or kept unsalable inventory on the books. Writing off inventory reduces a company’s earnings, and if the valuation was based on some measure of earnings, Buyer could claim she overpaid for the business.
Failure to record liabilities correctly: Often, Buyer may claim Seller didn’t properly record employees’ accrued (that is, unused) vacation.
If Buyer disputes the value of working capital and asks for a substantial post-closing adjustment, Seller may have to live by the terms of the purchase agreement. This situation can be costly for Seller; a Seller in this predicament should consult with his attorney.
The Buyer’s post-closing working capital calculation can be a classic “Seller beware” moment. An aggressive Buyer may create some issues by claiming Seller didn’t properly account for certain assets or liabilities.