Purchase Price: Why the Headline Number Is Only the Beginning

A buyer offers EUR 100 million for a company. The seller accepts. It may appear that the most important economic point of the transaction has been settled.

In reality, one of the most complex negotiations may only be beginning.

In M&A, the headline valuation and the amount ultimately received by the seller are not necessarily the same thing. Between them sit questions of cash, debt, working capital, leakage, completion accounts, deferred consideration, earn-outs and other adjustments that can materially change the economics of the deal.

For this reason, the purchase price provisions of an SPA are not simply the section in which lawyers record a number already agreed by the parties. They translate a valuation concept into the amount that will actually be paid at closing — and, in some transactions, into amounts that may only be determined months or years later.

This is one of the clearest areas in M&A where legal drafting and financial analysis cannot be separated.

Enterprise value is not the same as equity value

A common starting point in M&A negotiations is the enterprise value of the target. Broadly speaking, enterprise value reflects the value attributed to the operating business independently of how that business is financed.

But the seller is selling shares, not an abstract enterprise value. What ultimately matters to the shareholders is the equity value they receive.

This is why many transactions are negotiated on a cash-free, debt-free basis. The agreed enterprise value is adjusted to reflect the target’s financial position at the relevant date. Debt-like items are generally deducted, while cash or cash-like items may increase the amount payable to the seller.

The difficulty lies in determining what actually constitutes cash and debt.

Bank borrowings are obvious. Other items may be less so. Shareholder loans, accrued interest, unpaid bonuses, factoring arrangements, certain tax liabilities, transaction expenses or lease obligations may become the subject of negotiation depending on the agreed definition of indebtedness.

Similarly, not every amount sitting in a bank account necessarily represents freely distributable cash. Restricted cash or amounts required for the ordinary operation of the business may need different treatment.

A purchase price formula therefore needs more than financial logic. It requires precise contractual definitions capable of producing the economic result that the parties intended.

Working capital: paying for a business that can continue operating

Debt and cash are only part of the equation.

A buyer generally expects to acquire a business with a normal level of working capital — enough receivables, inventory and other current assets, net of relevant current liabilities, to allow the company to continue operating normally immediately after closing.

If the seller extracts too much working capital before the transaction completes, the buyer may technically acquire the same company but have to inject additional cash immediately after closing simply to keep the business functioning.

For this reason, many purchase price mechanisms compare actual working capital at closing against an agreed or normalized target.

If actual working capital is below the target, the purchase price may decrease. If it is above the target, the seller may receive an upward adjustment.

The financial principle is relatively intuitive. The legal complexity comes from defining precisely what goes into the calculation, which accounting policies apply and how exceptional or seasonal items should be treated.

This is often where seemingly small drafting differences can have significant economic consequences.

Completion accounts: calculating the price after closing

One traditional way to deal with these variables is through completion accounts.

Under this mechanism, the parties agree a provisional purchase price at closing. After closing, accounts are prepared showing the target’s actual financial position at the agreed measurement date, typically covering cash, debt, working capital and any other agreed adjustment items.

The final purchase price is then recalculated using those figures.

This approach can provide a relatively precise economic result because the price is based on the company’s actual position at closing. But it also means that part of the price remains unsettled after ownership has already transferred.

That can create a second negotiation.

The buyer may interpret an accounting item differently from the seller. The parties may disagree on whether an amount is debt-like, whether a receivable should be included in working capital or whether historical accounting practices have been applied consistently.

A well-drafted SPA therefore needs to establish not only the formula but also the accounting hierarchy, preparation procedure, review rights, timetable and dispute-resolution mechanism.

Often, unresolved accounting disputes are referred to an independent expert rather than ordinary litigation.

From an advisory perspective, the quality of this drafting is critical because a purchase price mechanism should reduce uncertainty, not simply move the valuation dispute from signing to the post-closing period.

Locked box: fixing the price before closing

The locked-box mechanism takes a different approach.

Instead of recalculating the target’s balance sheet after completion, the equity price is fixed by reference to a historical balance sheet — the locked-box accounts — prepared at an agreed date before signing.

Economically, the buyer is treated as having the benefit of the business from that date, even though legal ownership transfers later.

Because the price is generally fixed, there is no traditional post-closing true-up based on completion accounts. This can provide greater price certainty and allow the seller to know in advance how much it will receive.

But that certainty creates another concern.

If value is transferred out of the company between the locked-box date and closing, the buyer may acquire a business worth less than the business reflected in the agreed price.

The SPA therefore normally includes anti-leakage protections.

Leakage may include dividends, distributions, payments to shareholders or related parties, transaction bonuses paid for the seller’s benefit or other transfers of value outside the ordinary course.

Certain payments may instead be specifically identified as permitted leakage and taken into account when the price is negotiated.

The locked-box mechanism therefore replaces the post-closing price adjustment with a different form of protection: the seller effectively promises that value will not be extracted from the company during the locked-box period except as expressly agreed.

Completion accounts or locked box?

There is no universally superior mechanism.

Completion accounts provide the buyer with greater protection against changes in the target’s financial position before closing but leave the final price open to adjustment and potential dispute.

A locked box offers greater certainty and a cleaner exit for the seller but requires the buyer to have sufficient confidence in the historical accounts and appropriate protection against leakage.

The choice can also be influenced by the transaction process.

In a competitive auction, sellers often prefer a locked-box structure because bidders can be compared on a more consistent basis and the seller can seek price certainty earlier in the process.

In other transactions, especially where the balance sheet may change materially before closing, completion accounts may provide a more appropriate mechanism.

The decision is therefore not merely accounting-driven. It also reflects negotiating leverage, transaction timetable, diligence quality and the degree of certainty each party is seeking.

Earn-outs: when the parties disagree about the future

Sometimes buyer and seller agree on the business but disagree on what it will be worth.

The seller may expect significant growth over the next two years. The buyer may accept the potential but refuse to pay today for performance that has not yet occurred.

An earn-out can bridge that gap.

Part of the purchase price is made contingent on the target achieving agreed future results, such as revenue, EBITDA, customer milestones or other performance indicators.

In theory, this aligns price with performance.

In practice, earn-outs are among the purchase price mechanisms most capable of generating post-closing disputes.

Once the buyer controls the company, its decisions can affect whether the earn-out is achieved. It may change pricing, integrate the business into a wider group, allocate costs differently, alter investment levels or discontinue products.

The SPA therefore needs to define not only the performance metric but also how the business will be operated during the earn-out period, how the relevant figures will be calculated and what restrictions, if any, apply to the buyer’s conduct.

The legal drafting must anticipate a basic tension: the seller remains economically interested in a business it no longer controls.

From an advisory perspective, an earn-out can be useful to bridge a genuine valuation gap. It should not be used merely to postpone a disagreement the parties have been unable to resolve.

Deferred consideration, holdbacks and escrow

Not all amounts need to be paid at closing.

Part of the consideration may be deferred, with payment scheduled for a later date regardless of future performance. This can assist financing, create an element of seller financing or simply form part of the negotiated economics.

The seller will naturally focus on credit risk: if the buyer is obliged to pay in two years, what protection exists if its financial position deteriorates in the meantime?

Security, guarantees, interest and acceleration provisions may therefore become important.

A portion of the purchase price may also be retained in escrow or subject to a holdback to secure potential post-closing claims.

That introduces another question into the negotiation: whether the seller should receive the full price immediately or whether part of it should remain unavailable until certain risks have expired or been resolved.

Again, this is not separate from the overall valuation.

A EUR 100 million offer paid entirely in cash at closing is economically different from EUR 100 million where EUR 15 million is deferred, EUR 10 million depends on an earn-out and EUR 5 million remains in escrow.

The headline figure may be identical. The quality and certainty of the consideration are not.

The advisory perspective: compare offers on more than price

This becomes particularly important in competitive sale processes.

A seller may receive two offers:

Buyer A offers EUR 105 million, but part of the consideration is contingent on future performance and the transaction includes significant price adjustment mechanisms.

Buyer B offers EUR 100 million with a fixed locked-box price and fully funded cash consideration at closing.

Which is the better offer?

There is no automatic answer.

The analysis must consider not only nominal valuation but also certainty of proceeds, timing of payment, adjustment risk, financing certainty and probability of completion.

This is why advisers should be careful when presenting competing bids purely by reference to the headline price.

A higher enterprise value does not necessarily produce a higher or more certain return to the seller.

Likewise, a buyer should not focus solely on negotiating the lowest possible headline number. The purchase price mechanism itself may provide substantial economic protection if properly structured.

Drafting the economics of the deal

Purchase price provisions demonstrate why an SPA cannot be divided neatly between "legal" and "financial" sections.

The lawyers may draft the formula, but the formula represents a financial concept.

The financial advisers may calculate working capital, but their calculation only matters if it corresponds to the contractual definition.

The parties may agree a valuation, but that valuation only becomes meaningful once the agreement explains how it translates into consideration payable to the seller.

This requires close coordination.

Terms such as cash, debt, working capital, leakage and EBITDA may appear familiar, but in an SPA their meaning is contractual. If the parties want a particular item included or excluded, that intention needs to be expressed with sufficient precision.

The objective is not merely to produce technically sophisticated drafting. It is to ensure that the contract and the valuation model produce the same answer.

The headline number is only the beginning

Purchase price is often discussed as if it were the simplest element of an acquisition: buyer offers a number, seller negotiates it, and the parties eventually agree.

In sophisticated M&A transactions, that number is often only the starting point.

The final economic outcome depends on how enterprise value becomes equity value, how cash and debt are defined, what level of working capital the buyer receives, whether the price is fixed or adjusted after closing, whether value can leak from the company and whether part of the consideration depends on future events.

These mechanics can move substantial value from one side of the transaction to the other without changing the headline valuation at all.

That is why negotiating purchase price means more than negotiating how much a company is worth.

It also means negotiating how that value will be measured, protected and ultimately paid.