This book is for drafters of Mergers & Acquisitions (M&A) contracts. It provides an overview of purchase price adjustment tools, manipulation issues, purchase price calculation standards and the inter-relationship of such clauses. Chapter 2 discusses the basics of M&A, such as the scope of definition for M&A, and the different motives and phases during the M&A process. Chapter 3 provides a brief introduction into company valuation methods. Various valuation methods are involved in purchase price adjustment issues, hence it is essential to know their components to obviate manipulation potentials. In chapter 4, various guarantees are highlighted where its breaches can also result in purchase price adjustment. Discussion focuses on the guarantees under German law, which have different impacts depending on the magnitude. An ambiguously drafted clause can have the surprising opposite effect desired by the parties. This leads to one of the central themes of the paper precise formulation of clauses is the foundation for good contract drafting as it reduces potential future disputes. The main chapter of this book is chapter 5 where the two tools which directly influence the purchase price will be discussed: retrospective purchase price adjustments (post-closing adjustments) and future-oriented purchase price adjustments (earn-outs). The differences, advantages and disadvantages for both parties, the appropriate metric, manipulation issues and the calculation of the purchase price adjustment will be covered to guide the drafter of common foreseeable problems. Chapter 6 provides a brief introduction to issues which can arise relating to dispute resolution, which are common avenues in international M&A transactions as arbitration does not necessary always follow the set international rules. Other clauses in an M&A contract also have influence indirectly, on the purchase price, so chapter 7 covers the matter of coordination of purchase price influencing clauses.

Chapter 5 PURCHASE PRICE ADJUSTMENT TOOLS Purchase price adjustment clauses in M&A contracts are an integral designing instrument for both parties. Parties agree to them in order to find a fair and appropriate purchase price. They are in most cases of a greater economic relevance than guarantees.175 It does not matter if a share deal or an asset deal is the transaction mode. Purchase price adjustment tools are relevant for both. Purchase price adjustments are viewed from a certain date which is the closing date. This is the initial point where a retrospective or a future-oriented purchase price adjustment can take place. Retrospective purchase price adjustments, also called post closing adjustments, address the time period between the signing and the closing date. They focus on incidents which occurred in the past from the perspective of the closing date. Future-oriented purchase price adjustments, commonly known as earn-outs, concentrate on future events occurring subsequent to the closing date. The purchase price can be adjusted upwards as well as downwards. Caps, upper limits, are possible but not common. Post closing adjustments and earn-outs can be individually or collectively implemented in M&A contracts. This depends on the parties’ intentions, the nature of the transaction and the scope of the adjustment. Before thinking about purchase price adjustments, the parties have to ask the question of whether they are really necessary. There are situations where commonly, a purchase price adjustment clause is redundant. These situations can be: • Distressed equity: When insolvent companies are sold, liquidators are usually interested to exclude purchase price adjustment clauses in the contract, because they need the money as soon as possible, to satisfy the creditors. The buyer’s interests are protected through a lower purchase price, since the liquidator will avoid any warranties and guarantees in the contract. • Management Buy-Outs: When the internal management is taking over the company or parts of it, it is expected that they know the value of the company and can calculate the exact purchase price, since they have access to all the relevant data. • Acquisition of small companies: Companies that are sold for a small purchase price (e. g. for less than three million Euros) do not need purchase price adjustment clauses either. The costs of calculating the appropriate purchase price are disproportioned to the actual purchase price. • Privatisation: If a company is owned by the public sector and subsequently transferred to the private sector, a fixed price is preferred by the government. Therefore, purchase price adjustment clauses are not volitional, because they are politically difficult to communicate. On the other side, there are various theoretical situations where purchase price adjustments make sense for both parties. However, the practical experience illustrates that the real motives for the implementation of purchase price adjustment clauses in M&A contracts of the parties are obscure. The following list illustrates some of the situations where purchase price adjustment clauses are appropriate: • Adjustment of basis of valuation: If assumptions change, on which the parties relied for the valuation process of the company, these changes have to be adjusted at the key date. For example, if the assumption was that the company will be transferred ‘debt-free’, but there are still debts at the closing date (a possible key date), the price has to be adjusted. • Changes during temporary execution blocks: Signing and closing are usually not on the same date. This temporary gap can lead to change in values, since the company is in a constant flow, and the purchase price has to be adjusted (post closing adjustment). • Incomplete basis of valuation: If the parties signed the contract, although knowing that various data have not been determined yet, a later purchase price adjustment has to take place. Reasons for that can be delayeddetermination of the financial statement or legal limitations which prevented an extensive determination of the basis of valuation. • Dispersal of future chances: The parties can base the purchase price on the future performance of the company. Purchase price adjustment has to take place if the metrics, like revenue, profit or equity, changes in the future to positive as well as to negative (earn-out). If the parties come to the solution that purchase price adjustment is essential, the adjustment process follows a structured procedure. Firstly, the company valuation method has to be agreed by the parties to determine the value of the company and hence the purchase price (see chapter 3). Private equity companies come to play a major role in M&A transactions, whereby company valuation methods build the basics for purchase price evaluation and hence the basics for purchase price adjustments. Secondly, the metrics, which scale the change and are the basis for the adjustment process (such as equity, revenue, profit, working capital, et cetera), have to be verified. Guarantees are used to ensure the accuracy of these metrics (see chapter 4). They are not only a way to adjust the purchase price themselves, but they are also important to assure the realisation of retrospective and futureoriented purchase price adjustment clauses. During the next step, the parties have to identify what kind of purchase price adjustment tool they prefer: post closing adjustments, earn-outs or both. In the last step, securing the means for payment process and dispute resolution have to be set. A legal counsel has to be careful in drafting this kind of clauses. In the ideal case, a purchase price adjustment clause is precise, detailed, fair and simple so that a neutral third person would have no problems in understanding and verifying. In the unpleasant case of dispute resolution, the clause has to be formulated in a way that there is no room for any interpretation. This is very difficult to achieve, since those clauses might support one party more than the other and barriers, mistrust and antipathy is spread in negotiations easily.186 This would be the exact opposite the parties want to achieve.

• Merger & Acquisition

• Purchase Price Adjustment

• Earn-out

• Guarantee

• Company Valuation

Alexander Nürk, LL.M., MBA, Rechtsanwalt, Law degree from the University of Constance, Master of Law from Victoria University of Wellington, Master of Business Administration International Management from University of Nürtingen-Geislingen.