Merger and acquisition (M&A) transactions rarely turn out precisely as the parties anticipated when they negotiated the deal and signed the documents. So it’s not unusual for disputes to arise over contractual purchase price adjustments, representations and warranties, and earnout provisions. Determining liability and computing damages in these disputes involves a combination of business valuation, forensic accounting and economic analysis techniques.
Did The Buyer Get What It Bargained For?
Some of the most challenging disputes involve “benefit of the bargain” claims. Essentially, the buyer argues that the value of the business is less than what the seller represented it to be. Suppose, for example, that Company A acquires Company B for five times earnings before interest, taxes, depreciation and amortization (EBITDA). Company B’s EBITDA for the 12-month period ending on the closing date is $20 million, so the purchase price is $100 million (5 × $20 million).
After closing, Company A alleges that Company B’s financial statements contained material misrepresentations under U.S. Generally Accepted Accounting Principles (GAAP). Company A alleges that Company B overstated its EBITDA by $3 million. As a result, it bargained for a business worth $100 million but received a business worth only $85 million (5 × $17 million).
Can It Get Complicated?
In this example, assuming Company A’s allegations are true, it seems clear that the buyer was damaged to the tune of $15 million by Company B’s inaccurate financial statements. But many post-acquisition disputes are less clear-cut. Suppose, for example, that Company B’s financial statements are accurate, but it loses a customer that contributes $3 million to the company’s annual EBITDA just before closing and fails to disclose this development to Company A. On the one hand, Company A might argue that the customer loss reduces the company’s EBITDA to $17 million and, therefore, reduces its value to $85 million.
On the other hand, Company B 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 those lost revenues. Company B’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 Company B can show that the company’s postclosing performance was in line with Company A’s expectations, it’s arguable that Company A received the benefit of its bargain, despite the loss of a major customer.
Another important issue is causation. Even if Company B is shown to have made misrepresentations or breached the purchase agreement, it may be able to rebut Company A’s causation arguments with evidence that the diminution in the company’s value was caused by adverse economic conditions or other external factors. In fact, if Company B can convince the court that Company A failed to meet its burden of proving causation, Company A 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 valuation specialist.
In litigation involving post-acquisition disputes, it’s critical to enlist economic, valuation and forensic accounting 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 post-acquisition economic damages.