The merger parties need to ensure there are no overlaps in defined terms that will be used to determine purchase price adjustments. While this seems obvious, mistakes with respect to this are made more often than many practitioners would think.
As a simple example, supposed a merger agreement had the following defined terms.
- “Cash” is defined as cash plus cash equivalents, including accounts receivable.
- “Net Working Capital” is defined as Current Assets minus Current Liabilities.
- “Current Assets” are defined as Cash and other current assets in accordance with GAAP.
- “Current Liabilities” are defined as current liabilities in accordance with GAAP.
The problems with these terms might not be immediately obvious since each in isolation seems generally reasonable. However, with these terms, the parties might have just counted accounts receivable twice since it is in the definition of cash and is also a current asset. The parties might also be including transaction expenses in Current Liabilities even if they already reduced the closing purchase price.
To solve for issues such as these, better definitions might be something like:
- “Current Assets” are defined as Cash and other current assets not already included in Cash in accordance with GAAP
- “Current Liabilities” are defined as currently liabilities in accordance with GAAP other than those already factored into the Closing Purchase Price.