Stephen H. Berardi, BridgeTower Media Newswires
With an increase in commercial real estate merger and acquisition (M&A) transactions, it is important for CPAs involved to understand the post-acquisition dispute issues that often arise after closing. CPAs who proactively consider common post-acquisition dispute issues before an agreement is reached can minimize the chances of being distracted with such disputes, and can instead focus on integrating the newly acquired business, driving operational efficiency and setting the company on a path for growth.
M&A agreements often contain a post-closing adjustment to the purchase price, which typically reflects differences in the balance sheet of an acquired company between the date a deal is negotiated and the date the transaction closes. While the methodologies for adjustments vary from one agreement to the next, adjustments are often based on the change in a business’s net working capital, net assets and/or company debt. Disputes often arise because the parties to an M&A agreement have differing opinions regarding the amounts that should be recorded on the closing balance sheet. In the commercial real estate industry, these disputes often focus on the application of generally accepted accounting principles (GAAP) within the context of the terms of the M&A agreement.
For example, M&A agreements may contain language that requires the closing date balance sheet to be prepared in accordance with GAAP and consistent with a company’s past policies, practices and procedures. Post-closing purchase price adjustment disputes often arise when a company’s past practice is not in accordance with GAAP and the M&A agreement is silent on what should prevail — past practices or GAAP.
In real estate industry M&A transactions, we often see this issue in regards to security deposits. Many companies simply record security deposits as a current liability on the balance sheet, even though many of the security deposits will not be returned for more than a year and could be more appropriately classified as a long- term liability under GAAP. If the post-closing purchase price adjustment is based on a net working capital measurement, a dispute could occur.
CPAs can play an important role in minimizing transaction disputes by suggesting clarifying language in the agreement that specifies which methodology takes precedent. If the parties’ intent is that the closing date balance sheet be prepared in accordance with past policies, practices and procedures, then the parties should consider avoiding any reference to GAAP in the M&A agreement provision that discusses the preparation of the closing date balance sheet.
As CPAs are aware, GAAP requires management to make judgments and estimates in preparing financial statements. However, in an M&A transaction, buyer management and seller management might have differing estimates for the same balance sheet item, even though both estimates are in accordance with the technical requirements of GAAP. Real estate companies, for instance, often enter into construction projects, which are accounted for in financial statements using a percentage of completion methodology.
With this methodology, it is necessary for management to make judgments and estimates about the future costs to complete the construction project. In some transactions, the buyer’s assessment of such costs to complete is significantly higher than the seller’s assessment of the costs to complete. As a result, such items can be the focus of post-acquisition dispute claims. CPAs involved in an M&A transaction in the real estate industry may want to suggest the inclusion of language in the agreement that removes the subjective nature of such estimates.
In addition to net working capital adjustment provisions, many M&A agreements contain earn-out provisions intended to bridge the buyer and the seller’s differing views on the value of a business. Because these provisions frequently have a financial-related metric that the seller needs to achieve in order for the buyer to pay the additional purchase price, it is important to be aware of changes in GAAP that could impact an earn-out calculation.
While earn-out provisions may not be seen in every real estate M&A transaction, it serves as a good example to highlight how changes in GAAP can impact an M&A transaction. Because earn-out targets are often based on historical financial performance that are projected for future performance, the new revenue recognition standards that are effective in 2019 may affect the calculations during the earn-out periods. This inconsistency could result in post-closing issues because the seller may or may not earn contingent consideration solely due to a change in GAAP and not the underlying performance of the company. CPAs can provide value to their clients by making sure that changes in GAAP are taken into account when the parties are negotiating the terms of an M&A agreement.
The more CPAs take the time early in the process to consider common M&A post-acquisition dispute issues within the real estate industry, the more proactive they can be in providing guidance to management during negotiation of the terms of an agreement.
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Stephen H. Berardi, CPA, is a principal at Mengel, Metzger, Barr & Co. LLP and can be reached at (585) 423-1860 and SBerardi@mmb-co.com.
