Meaning
Contractual mechanisms used in acquisitions reconcile the estimated price paid at closing with the actual value of the assets and liabilities on the closing date. This purchase price adjustment accounts for the movement in balance sheet items such as inventory and debt that occurs between signing and completion. It ensures that the buyer pays only for the net value actually delivered at the point of handover.
Financial Audit
Financial experts prepare a completion balance sheet within a specified number of days after the transaction is finalized. The purchase price adjustment is calculated by comparing these final figures against the target levels previously agreed upon in the purchase agreement. If the closing working capital is higher than the target, the buyer pays more, while a lower amount results in a refund from the seller.
Risk Mitigation
Buyers use this tool to protect themselves against the erosion of value caused by the seller actions in the pre-closing period. A purchase price adjustment prevents a seller from delaying the payment of trade creditors or accelerating the collection of receivables to artificially inflate the cash position. It aligns the economic reality of the business with the expectations formed during the due diligence process.
Settlement Process
Parties usually have a window of time to review the proposed figures and raise any objections before the payment is made. Once the purchase price adjustment is agreed upon, the funds are typically released from an escrow account or paid directly between the parties. Finality is achieved through a signed settlement letter that confirms the definitive price of the acquisition.
Disputed items are referred to an independent accounting firm whose decision is usually final and binding. This process removes the need for litigation and provides an objective resolution to financial disagreements.