Advanced Financial Issues in Acquisition Agreements

2 Part Course | Learn about Cash Free Debt Free, the Working Capital Adjustment, the Locked Box Mechanism approach and how to manage the Value Accrual

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A one-day course presented over two-half days in a virtual class from 9:30am to 1:00pm UK time

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Download: Course Outline

Part One

Structuring the Purchase Price: Overview of Different Approaches

Enterprise vs Equity Value
Completion Accounts
Locked Box Approach
Earn-outs

Main Components in the Equity Bridge

Reconciling Enterprise to Equity Value
Key differences between the main items in M&A and traditional Valuations
Main adjustments in the Equity Bridge in M&A
- Debt
- Cash
- The Working Capital Delta
- Other adjustments & how to negotiate them
  - Minority Interests
  - Preference shares: Convertible, Redeemable, other
  - Non-operating real estate/assets (valuation?)

What Does “Debt” Include?

Why M&A debt definitions are broader than traditional accounting
Impact on valuation and deal structure
Common areas of dispute in debt classification
The main categories of Debt in M&A
- Traditional debt-like items (e.g. bank debt)
- Deal related items
- Debt or working capital
  - Deferred revenue – how to approach this
  - Prepayments
- Contentious “debt” items
  - Pensions (unfunded)
  - Deferred Capex
  - Deferred/reduced rent
  - Stretched creditors
  - Operating leases
  - Environment liabilities
  - Supply chain finance
- Contingent debt-like items; potential approaches
  - Litigation
  - Deferred Tax
  - Warranty claims (for products)
‘Sweeper’ clauses in the SPA
Off-balance sheet items
Director’s Loan Accounts (s455) [UK only]
Treatment of Leases
- Operating vs finance leases
- IFRS 16 vs FRS 102
- Practical issues and impact on valuation

What Does “Cash” Include?

How and why treatment of cash differ in M&A vs traditional valuations
Which cash figure matters – Bank vs Ledger
The three main types of cash in M&A
- Surplus Cash - retained by seller or paid for separately by buyer
- Trapped Cash - negotiation points and treatment options
  - Regulatory cash
  - Withholding taxes
- Operating Cash: how to determine operating cash
  - Review historical patterns
  - Map operating cash cycle
  - Establishing the ‘buffer’
Review of selected items
- Rent deposits
CASE STUDY: Calculating the Equity Bridge by reviewing key aspects of “Debt” “Cash” and “surplus assets”. Discussion on how to treat deferred revenues

Completion Accounts

First-principles – the 6 key issues
Composition of the Completion Accounts
- The three bases of preparation of the Completion Accounts
- Establishing the hierarchy & why it matters
  - Buyer’s perspective
  - Seller’s perspective
  - GAAP/ IFRS override – good or bad?
The main areas of dispute (& how to resolve them)
- Setting IFRS date
- Directors’ judgement – WIP
- Ambiguous accounting policies
- Bad debts – what is an adequate provision
- Obsolete vs damaged inventory
Four main categories in the Accounts that require clarification
CASE STUDY: Reviewing the Accounting principles and the “hierarchy of accounts” – which approach is best? Does the abolition of Operating Leases actually impact the Accounts?

Net Working Capital Delta

Overview: The Working Capital Delta in M&A
- Why working capital adjustments exist in M&A but not in traditional valuations
- Working capital as a value protection mechanism
- The interaction between net debt categories and working capital definitions
No “Standard” Accounting definition of working capital
Additional challenges in defining working capital in M&A (typical exclusions)
- Cash
- Other debt-like items excluded
- Impact of Seasonality/ cyclicality
- Positive vs Negative
- Erratic profiles & how to manage the
- Broad vs narrow definition of working capital
- “Judgement” areas
- Intra-monthly movements
- Dealing with zero balances
Setting the Working Capital PEG/Target: pros and cons of various approaches
- Average
- ‘Normalised’
- ‘Run-rate’
- Choosing the reference period for determining the PEG
- Historic TTM
- Challenges when valuation based on prospective multiples
Dealing with differing working capital profiles
- Seasonal /cyclical
- Growth
- Positive vs Negative
- Erratic profiles & how to manage them
- Review specific issues that affect Net working capital adjustment across various Sectors
  - Retail
  - Industrial Markets
  - Technology
  - Financial
  - Advanced Financial Services
  - Construction
  - Transport
  - Public Sector
CASE STUDY: Determining the working capital ‘target/peg’

Part Two

Locked Box Mechanism

Four key areas of risk for Buyers
Leakage vs Permitted Leakage; three categories
- Permitted leakage (no adjustment to equity)
- Permitted leakage (reduces to equity)
- Leakage that is not permitted or agreed
The Value Accrual: three approaches
- The traditional approach (interest) – what’s the typical market rate?
- Using a ‘ ticker”
- Using actual profits/cash
Types of tickers
- Cash profits
- EBITDA based variants
- Revenue-based
- Multi-stage tickers
- Tickers for loss-making targets – potential solutions
Problems with actual profit value accruals
Which ‘Accounts” should be used for deriving the Locked Box
Choosing the Reference Date Balance Sheet (RDBS) for the Locked Box
- Annual audited accounts
- Interim audited accounts
- Management accounts
- Carve-out accounts (for divisions/units within larger groups)
- Vendor Due Diligence (VDD) reports
- Pros & cons of each
How reliable is the Locked Box
- Issues for buyers
- Issues for sellers
- Potential solutions for both parties
- What are the critical areas of focus
Decision Tree - is the Locked Box Mechanism appropriate & or desirable
Case study on Leakage
Case study on the value accrual for loss-making firm

EBITDA Adjustments

Where and why does EBITDA matter?
How to derive EBITDA; the main adjustments
- Net interest
- Depreciation & Amortisation
- Exceptional items
- Synergies
- Business optimisation initiatives
EBITDA ‘adjustments’ by ownership structure (what to look for)
How Proforma EBITDA matters in M&A
- Typical adjustments for PE-owned firms
- Typical adjustments for Owner-managed firms
- Typical adjustments in corporate entities
- Sector-specific adjustments
- Checklist of EBITDA manipulations (with real-life examples)
EBITDA manipulation (impact & examples)
- How accounting policies can affect EBITDA
- Impact of areas affected by ‘Management’ discretion (WIP, real estate valuation)
  - Revenue recognition issues
  - Expense classification
  - Asset valuation impacts
  - Working capital manipulation
  - Provisions and reserves

Earn-Outs

Anatomy of an Earn-out
- The two key aspects - duration & key performance met
- Other important issues
  - Dispute resolution
  - Payment structure/intervals
  - Acceleration clauses (early termination)
  - Tax considerations
  - Caps and floors
Buyer’s perspective: key issues
Seller’s perspective: key issues
Selecting the appropriate benchmark
- Financial benchmarks
- Other benchmarks (Life sciences, Renewables, Retail, Services)
Earn-out Duration – key factors to consider
- Industry norms & business cycle
- Business profile/revenue streams
- Integration / Transition period
- Milestones & objectives
- Other considerations
- Review of examples from various sectors
- Frequency of payouts: annual, quarterly other?
Manipulation of financial benchmarks: considerations for buyers
- Dealing with synergies
Key risks for the Buyer
- Who determines how the consideration is satisfied
- Tactics for keeping the vendor interested
- The premature departure of the vendor(s)
- Issues for Listed buyers
Key risks for the Seller
- Disputes RE the benchmark
- Buyer is acquired
- Security for any deferred consideration (Buyer is insolvent)
CASE STUDY: Earnouts – identifying key risk areas and how to mitigate them. Dealing with consideration loan notes and shares (what are the pitfalls)

Deals Based on the Net Asset Value of a Company

Which sectors use the Net Asset Value of a Company (NAV) approach
Problems with the definition of NAV e. Net Asset Value of a Company (q.v. Denware case)
Potential problem areas with Inventory
- What is 'cost'
- What is included in WIP?
- What is 'net realisable value' and 'net realisable value accounting'?
- Slow-moving & obsolete inventory
- 'extraneous' inventory
Potential problem areas with Receivables
Long-term contracts
Valuation and impairment of Long-term assets
Provisions generally
Advanced Financial services instruments

Please be advised that there is some content overlap between this course & our 'Advanced Negotiation Issues in M&A' & 'Sale & Purchase Agreements' courses. If you are looking to book one or more of these courses, we would advise contacting us to discuss which combination of courses would be recommended.

Our Advanced Issues in Acquisition Agreements course trainer is a consultant, public speaker and author with expertise in private equity, debt advisory, restructuring and infrastructure. He is a Senior Advisor to KPMG Finland, a Senior Advisor to Reorg EMEA Covenants, the leading provider of information to the European High Yield community, and a Senior Consultant to Grant Thornton UK.

We provide training programmes to a wide range of blue-chip clients in Europe, Africa, the Middle and Far East, North America and Australasia. In-house clients include banks (BNP Paribas, Société Générale, ING, Barclays Capital, Bank of China, RBS, SEB); lawyers (Baker & McKenzie, Skadden Arps, Sullivan & Cromwell, Cadwalader, Latham & Watkins, Weil, White & Case); advisory firms (Lazard, PWC, M&A International, KPMG, EY, Deloitte); PE firms (Cinven, Advent, Barings Asia, Waterland); corporates (Siemens, Airbus, Turkcell, Candy Crush, Gunvor, Statkraft) and governmental bodies (the UKLA, the EBRD, the ECGD, Omani Oil Corp.)

He qualified in South Africa both as a Chartered Accountant, with Deloitte and as a lawyer with Hofmeyr where he was involved in structuring several high-profile project financings including BMW 3 Series, Ford Siera, GM, Sappi and Mondi.

When he moved to London and joined Lazard Brothers as a corporate finance executive he was involved in a wide range of public and private cash-free debt-free transactions. Subsequently, he joined Hoare Govett as an assistant director, where he acted as an advisor to smaller listed companies and was involved in several syndicated Euro-Equity Initial Public Offerings.

In 1991, he joined ABN Amro’s cross-border M&A team before being transferred to MeesPierson Corporate Finance as a Director in Cross-Border M&A where he was also involved in a number of deals in Central Europe. During this time, he was a member of the EU-PHARE programme and advised the Estonian government on its privatisation programme.

He is the Programme Director at the City Business School, London, for Infrastructure Finance for the M. Sc. programme in Business Administration and Finance.

He is a member of the Institute of Chartered Accountants in England & Wales and the South African Institute of Chartered Accountants. He completed a BA and an LLB at the University of Natal and a B. Compt. (Hons) at UNISA.

Our course focuses on the following key areas of advanced financial issues in acquisition agreements:

The Equity Bridge - Understand the essential components of the Equity Bridge in M&A transactions, including debt, cash, working capital adjustments, and minority interests. Learn how these components bridge Enterprise Value to Equity Value and significantly impact the final purchase price.
Cash in M&A - Recognise how cash is categorised differently in M&A versus traditional valuations, with a focus on the three critical classifications: surplus cash (retained by seller), trapped cash (requires negotiation), and operating cash (assumed by buyer but excluded from working capital). Understand the inherent tension between these classifications and their impact on deal negotiations.
Debt in M&A - Appreciate why debt definitions in M&A extend far beyond traditional accounting principles to include "debt-like" items such as unfunded pensions, environmental liabilities, and deferred income. Learn to identify hidden debt-like items that can materially affect purchase price.
Working Capital - Understand why working capital adjustments exist in M&A but not in traditional valuations, serving as a key value protection mechanism. Master the challenges in defining ‘normalised’ working capital and setting the appropriate PEG/target, with awareness of sector-specific considerations.
Completion Accounts - Identify the critical challenges in selecting which accounts to use for completion accounts, establishing the appropriate accounting hierarchy, and resolving disputes that arise from different accounting approaches.
Locked Box Mechanism - Recognise the main risks in locked box transactions including leakage, reliability of the reference accounts, and value accrual. Understand the different approaches to value accrual through various ticker metrics (EBITDA-based, revenue-based, seasonal, and even negative tickers for loss-making businesses).
EBITDA - Appreciate why EBITDA is crucial in M&A, affecting valuation multiples, working capital adjustments, and earn-outs. Distinguish between legitimate EBITDA adjustments and manipulative practices, with the ability to identify common manipulation techniques using real-world examples.
Earn-outs - Master the structure and mechanics of earn-outs, including benchmark selection, duration, and protection mechanisms. Understand the key risk areas for both buyers and sellers and develop strategies to mitigate these risks in acquisition agreements.

This advanced course is designed for M&A practitioners who need to master the specialised financial mechanisms that can significantly impact transaction value. Unlike traditional finance courses that focus on valuation theory, this programme delves into the practical financial aspects of acquisition agreements that often determine deal success.

The course begins with the equity bridge concept—the critical link between Enterprise Value and Equity Value in M&A. We explore how seemingly standard financial terms take on specialised meanings in acquisition contexts, creating both risks and opportunities for dealmakers.

A core focus is understanding how cash is categorised in M&A transactions. We examine the three distinct classifications: surplus cash (typically retained by sellers), trapped cash (requiring specific negotiation), and operating cash (assumed by buyers but excluded from working capital). This categorisation creates natural tension in negotiations as buyers seek to minimise "surplus cash" while sellers aim for the opposite.

Similarly, participants will learn how debt in M&A extends far beyond traditional balance sheet definitions to include items like unfunded pensions, environmental liabilities, and deferred income—significantly impacting purchase price calculations.

Working capital adjustments—unique to M&A transactions and absent in traditional valuations—are explored as critical value protection mechanisms. The course addresses the challenges in defining normalised working capital and setting appropriate targets across different industry sectors.

Through case studies and real-world examples, participants will examine how deal structures (Completion Accounts vs. Locked Box) influence these financial mechanisms and learn common manipulation tactics, dispute areas, and sector-specific considerations that impact financial terms in acquisition agreements.

Special attention is given to EBITDA adjustments and their ripple effects across valuations, working capital calculations, and earn-outs. Using actual company examples, we'll demonstrate how EBITDA can be legitimately adjusted or potentially manipulated.

By the course conclusion, participants will possess the specialised knowledge needed to navigate complex financial aspects of M&A transactions, helping them capture or protect significant value during deal negotiations.

Definitely a course that I will push for our analysts to join. Great introduction to some of the tricky financial situations that we come across in a deal.
Amazing instructor giving numerous practical cases, motivating to a discussion.
Experienced trainer, Covered both buyer side and seller side, Focused on key topics.
There was a good level of detail in the training.
The course certainly helped me to understand what purchase price agreement mechanisms actually work like and what are the key problems and items that are negotiated between buyers and sellers. I am sure that the knowledge will be highly useful in negotiations regarding transaction documentation in the future. [The highlights were] the lecturer's profound knowledge of the subject and the use of real-life examples of how purchase price negotiations between big players were made and what impact they had on the sale proceeds.
So valuable to gain a deeper understanding of the financial models/calculations on which our drafting is based.

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