Most private deals price the business as debt-free and cash-free with a normal level of working capital. The business keeps trading up to closing, so the numbers on closing day are never the numbers you priced. The adjustment fixes that gap — and it is one of the most argued-over clauses in private M&A.
Our charges include applicable taxes. Disbursements are extra and billed at cost — itemized upfront, in writing, never hidden.
From $3,388.87 taxes included
A buyer paying for a business is paying for an operation that can run from day one. That means it needs inventory on the shelves and receivables coming in, offset by the payables that fund them. If the seller collects hard and stops paying suppliers in the last month, the buyer gets the same company with less cash inside it and has to inject working capital of its own. The adjustment is the mechanism that stops that transfer of value happening quietly.
It works in both directions. If the company closes with more working capital than the agreed target, the buyer pays the excess to the seller. If it closes with less, the price comes down or the shortfall comes out of a holdback. Buyers who assume the adjustment can only help them are often surprised at the first draft of the closing statement.
The adjustment is not a substitute for the indemnity. It corrects the level of ordinary operating assets and liabilities. It does not deal with a contingent liability, a disputed tax assessment or a broken representation. Agreements should say expressly that anything captured in the adjustment cannot also be claimed under the indemnity.
The target is usually a trailing average of the company's normalised working capital over a period long enough to smooth out the ordinary rhythm of the business. Seasonal businesses need care: a landscaping company at the end of March and the same company in July hold utterly different balance sheets, and a twelve-month average applied at the wrong closing date produces a large payment that reflects the calendar rather than performance.
The definition matters more than the number. Say explicitly what is in and what is out. Cash and bank debt are normally excluded, because they are dealt with separately in the debt-free cash-free calculation. Income tax balances, shareholder loans, intercompany accounts, deferred revenue, capitalised leases, accrued vacation and bonus liabilities, and any receivable from a related party all need a decision. Every one of them is a place where a first draft and a final statement can differ by real money.
Finally, fix the accounting. Saying the statement will be prepared in accordance with generally accepted accounting principles applied consistently with past practice sounds complete, but it is not — GAAP and past practice can point in different directions, and a company's past practice may not have been GAAP-compliant at all. State which prevails, and attach a worked example schedule showing the target calculated on the historical figures.
Shortly before closing, the seller delivers an estimated closing statement and the purchase price is adjusted provisionally against it. After closing, one party — usually the buyer, because it now controls the books — prepares the actual statement within the number of days the agreement sets. The other party gets a review period and access to the working papers and the accounting staff. Objections have to be raised in writing and item by item, with amounts, or they are deemed accepted.
Anything still in dispute goes to an independent accounting firm named in the agreement or chosen by an agreed process. That firm should be appointed as an expert, not as an arbitrator, with a mandate limited to the specific line items in dispute and no power to roam outside the range the parties have each proposed. Say who pays its fees, and say that its determination is final and binding absent manifest error. Without those words you can end up litigating the appointment as well as the number.
The most common failure is a definition that never gets tested against real numbers. Attaching a sample calculation built from the last audited or reviewed statements exposes the disagreements while both sides still want to close, rather than sixty days later. If the parties cannot agree the sample, they were never going to agree the closing statement.
The second is manipulation in the run-up. Buyers protect against it with covenants requiring the business to be operated in the ordinary course between signing and closing, no unusual collection or payment practices, and normal inventory and capital spending. The third is double counting — a receivable written off in the working capital statement and then claimed again as a breach of the accounts representation. Some parties avoid the whole mechanism with a locked box instead, pricing off a historic balance sheet and shifting economic risk to the buyer from that date.
A locked box fixes the equity price by reference to a historic balance sheet date. From that date the economic benefit of the business belongs to the buyer, and the seller promises there has been no leakage — no dividends, no bonuses, no payments to related parties — with a pound-for-pound indemnity for any that occurred. There is no post-closing adjustment at all. It is clean and it ends the deal on closing day, but it requires the buyer to be confident in the accounts at the locked box date, which usually means audited or reviewed figures.
The agreement should name a firm, or set out a process — each side proposes names, and a neutral body or an agreed method breaks the tie. Choose a firm with no relationship to either party and no conflict with the deal's auditors. It also matters that the firm is appointed as an expert with a narrow mandate limited to the disputed items, and that it must decide within the range of the two positions rather than substituting its own view of the whole statement.
Three things working together. The debt-free cash-free pricing means excess cash is not the buyer's to begin with. The working capital target catches the effect of aggressive collection or delayed payment, because those actions move receivables and payables. And the interim operating covenants between signing and closing prohibit acting outside the ordinary course. On a same-day signing and closing there is no interim period, so the target definition and the closing statement carry all the weight.
Longer than people expect. The closing statement is prepared after the accounts for the closing date are made up, the other side gets a review period, and any disputed items go to the independent accountant. It is normal for the final number to land a few months after closing, which is why part of the price is usually held back or held in escrow until it is settled. Build that timing into the agreement rather than leaving it open-ended.
Open your file tonight — a licensed Ontario lawyer will confirm everything with you by tomorrow.