When completing the sale of a business it is very common for there to be an agreed price, with various adjustments applied to that price as at settlement date to determine the exact amount of cash that will change hands. It is imperative for buyers and sellers alike to understand what adjustments are common and how they are calculated as these adjustments can sometimes make a material impact on the viability or otherwise of a business sale or purchase. This article sheds light on what adjustments are commonly applied and how they can impact buyers and sellers.
Adjustment Type One: Stock
It is very common for the value of stock to be added on top of the agreed price for physical assets and goodwill as part of a business sale. Largely, this occurs as the value of stock in most businesses is a moving target, hence buyers do not wish to agree to a fixed price for a business inclusive of stock, at the risk that a seller may run down the value of their stock holdings prior to completion, and sellers do not wish to commit to a fixed price for stock as they need to be able to continue purchasing normal levels of stock with the knowledge that they will be paid for stock that is on hand but not sold at the date of completion. To deal with these issues, is typical in a business sale for the value of stock to be calculated as at the settlement date following the completion of a formal stocktake.
Adjustment Type Two: Work in Progress
Similar to stock, it is very common for there to be adjustments made to a purchase price in consideration of work in progress. Work in progress becomes an issue for buyers and sellers in businesses where work becomes billable after the business invests in time and materials to produce a saleable product – think manufacturing companies. Typically in these circumstances, it is likely that the business in question will have jobs or work that is partially completed as at the point when the business sale is completed, however payment for that partially completed job may not come until the work is fully completed. Similar to stock, it is common for the purchase price to be adjusted in consideration of the work completed and monies due to be received for each particular job. For example, if a business has half completed a job and incurred half the anticipated time and material costs for a job there should be additional compensation payable to the seller equal to half of the price that the purchaser will charge to the customer for the job.
Adjustment Type Three: Employee Entitlements
Over time employees accrue entitlements like annual leave, long service leave and sick leave. These entitlements (in part or full) reflect true liabilities for the operators of a business, and accordingly it is common for some or all of the value of these entitlements to be adjusted for as part of the settlement. As purchasers typically absorb the responsibility for these entitlements, the adjustment normally results in a deduction in the proceeds that are paid to the vendor in the transaction. It is important to note here, that it is typical for there to be a full adjustment made with respect to annual leave entitlements as these entitlements generally meet the definition of being a current liability, however it is common for there to be partial adjustments made to long service leave and sick leave entitlements owing to the reality that it is not uncommon for these entitlements not to be realised.
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This article has only covered at a high level some of the more common adjustments in business sale agreements, however in reality there are many other adjustments that are often applied.
If you require advice in this area, contact us today on 02 9223 9166 to for a confidential discussion with one of our expert business sale or acquisition advisors.