How do purchase price adjustments work in acquisitions?
Takeaway: A purchase price adjustment is a standard M&A mechanism that "trues up" the deal price based on the actual financial condition of your company at closing, protecting the buyer from last-minute changes to your balance sheet.
When a buyer makes an offer to acquire your company, the purchase price is based on a set of financial assumptions about your business, particularly about its level of cash, debt, and working capital. However, the business does not stand still. Between the date you sign the merger agreement and the date the deal actually closes (which could be several weeks or months later), these financial numbers will change.
A purchase price adjustment is the formal, contractual mechanism used to account for these changes. It is a "true-up" that adjusts the final purchase price paid to the sellers up or down based on the company's actual financial condition on the closing date. This is a standard and expected part of nearly every M&A transaction.
The Purpose: Protecting the Buyer from a "Cash-Free, Debt-Free" Deal
Most acquisitions are negotiated on a "cash-free, debt-free" basis. This means the buyer is valuing the operating business itself, and they expect to receive it without any of the seller's cash or any of the seller's debt. The purchase price adjustment is the mechanism that makes this happen.
How the Adjustment Works
The "Target" Working Capital: In the merger agreement, both parties will agree on a "target" amount of net working capital (typically defined as current assets minus current liabilities, excluding cash and debt) that the company is expected to have at the time of closing. This target is usually based on the company's average historical working capital.
The Closing Balance Sheet: Immediately after the closing, an accounting is done to determine the actual net working capital on the company's balance sheet as of the closing date.
The True-Up:
If the actual working capital is less than the target: The purchase price is adjusted downward, dollar for dollar. The sellers effectively have to reimburse the buyer for the shortfall.
If the actual working capital is more than the target: The purchase price is adjusted upward, dollar for dollar, and the buyer has to pay the sellers the excess amount.
The same adjustment is made for cash and debt. The final purchase price will be increased by the amount of cash on the balance sheet at closing and decreased by the amount of debt.
A Source of Post-Closing Disputes
The purchase price adjustment is one of the most common sources of post-closing disputes. The buyer and the seller may disagree on the accounting principles used to calculate the closing balance sheet. To mitigate this, the merger agreement should be very clear about the specific accounting methodologies to be used.
While it can seem complex, the purchase price adjustment is a standard and fair mechanism. It ensures that the buyer is paying for exactly what they bargained for—the value of your operating business, independent of the cash and debt you happen to have on your books on the day the deal closes.
Disclaimer: This post is for general informational purposes only and does not constitute legal, tax, or financial advice. Reading or relying on this content does not create an attorney–client relationship. Every startup’s situation is unique, and you should consult qualified legal or tax professionals before making decisions that may affect your business.