Use a Multifaceted Approach to Tackle Postacquisition Disputes

Mergers and acquisitions (M&As) sometimes fail to meet the parties’ expectations. Examples of potential sticking points include contractual purchase price adjustments, representations and warranties, earnout provisions, and alleged misrepresentations by the seller. Determining liability and calculating damages in these disputes may involve a combination of business valuation, forensic accounting and economic analysis techniques.

Scrutinize Seller Representations

Some of the most challenging disputes involve “benefit of the bargain” claims. Essentially, this is when the buyer argues that the value of the business is less than what the seller represented it to be.

To illustrate, suppose ABC Co. acquires XYZ Co. for five times earnings before interest, taxes, depreciation and amortization (EBITDA). XYZ’s EBITDA for the 12-month period ending on the closing date is $10 million, so the purchase price is $50 million (5 times $10 million).

After closing, ABC alleges that XYZ’s financial statements contained material misrepresentations under U.S. Generally Accepted Accounting Principles (GAAP). ABC alleges that XYZ overstated its EBITDA by $1.5 million (or 15%). As a result, it bargained for a business worth $50 million but received a business worth only $42.5 million (5 times $8.5 million). If the allegations in this hypothetical example are proven true, it seems clear that the buyer was damaged to the tune of $7.5 million by XYZ’s inaccurate financial statements.

A forensic accountant can serve as an expert on whether the company’s financial statements complied with GAAP. If the statements don’t comply, the expert can also identify where the errors, omissions or manipulation happened — and how they would have affected EBITDA and the purchase price.

Consider Confounding Factors

Many postacquisition disputes are less clear-cut, however. Suppose, for example, that XYZ’s financial statements are accurate, but it loses a major customer that contributes $1.5 million to the company’s annual EBITDA just before closing and fails to disclose this development to the buyer. On the one hand, ABC might argue that the customer loss reduces the company’s EBITDA to $8.5 million and, therefore, reduces its value to $42.5 million.

On the other hand, XYZ might argue that this type of customer turnover is an ordinary part of its business and, as of the closing date, management was in negotiations with prospective new customers intended to replace the lost revenue. XYZ’s damages expert might present forecasts and other evidence showing that normal customer attrition isn’t expected to hurt the company’s future financial performance or market value.

Often, the company’s actual performance is relevant. If XYZ can show that the company’s postacquisition performance was in line with ABC’s expectations, it’s arguable that the buyer received the benefit of its bargain, despite the loss of a major customer.

Evaluate Causation

Another important issue is causation. Even if XYZ is shown to have made misrepresentations or breached the purchase agreement, it may be able to rebut ABC’s causation arguments with evidence that the diminution in the company’s value was caused by external factors, rather than the alleged wrongdoing by the seller. Examples of outside conditions that may depress a company’s value postacquisition include unanticipated adverse economic conditions, changes in government regulations, new competitors or technology, or the loss of a key employee.

In fact, if XYZ can convince the court that ABC failed to meet its burden of proving causation, ABC may not have a case for damages at all. Such evidence may require analysis and testimony by an industry expert or economist, in addition to the work of a business valuation specialist.

Assemble Your Team

In postacquisition disputes, it’s critical to enlist a team of financial experts to analyze issues of liability, causation and damages. Whether you represent the buyer or the seller, these experts can provide objective, market-based estimates of postacquisition damages.