How Purchase Price Adjustments Work in Share Purchase Agreements

In private mergers and acquisitions transactions in Ontario, it is customary for a share purchase agreement ("SPA") to include a mechanism that allows the purchase price to be estimated at closing and then adjusted after closing once the target company’s final financial position is confirmed. This approach helps ensure that the buyer pays for the business based on its actual financial condition at closing, rather than estimates made earlier when the transaction documents were finalized.

Most transactions begin with an agreed enterprise value for the business. From that starting point, the SPA typically includes a set of adjustments that convert enterprise value into the final equity purchase price.

Estimated Purchase Price at Closing

Because the parties usually do not have final closing date financial statements available on the day of closing, the seller typically prepares an estimated closing statement shortly before closing. This statement calculates an estimated purchase price based on the company’s anticipated financial position at the closing date.

The estimated purchase price generally reflects four common adjustments:

• Cash: Cash held by the business at closing is usually added to the purchase price.
• Working Capital: The difference between the actual working capital on closing and the established working capital peg.
• Indebtedness: Debt and similar liabilities are typically deducted.
• Transaction Expenses: Corporate transaction-related expenses (such as unpaid legal, accounting, or advisory fees) are also usually deducted.

The Working Capital Peg

Working capital represents the short-term operating assets and liabilities required to run the business. In most SPAs, the parties agree to a working capital “peg”, which is a target level of working capital that reflects the normal operating needs of the business.

If the company’s closing working capital is:

• Higher than the peg, the purchase price increases; and
• Lower than the peg, the purchase price decreases.

The peg is usually based on an average of historical working capital levels over a defined period, subject to quality of earnings analysis and adjustments.

The SPA will define working capital very precisely, and the definition often includes negotiated inclusions and exclusions that reflect the commercial expectations of the parties.

Items commonly included in working capital include:

• accounts receivable;
• inventory;
• prepaid expenses; and
• trade payables and other operating liabilities

The working capital definition used in an SPA often differs from the standard accounting definition. For example:

• Cash, transaction-related liabilities, shareholder items, and debt-like obligations are usually excluded from working capital and instead addressed through the cash, indebtedness or transaction expense adjustments.
•  Buyers typically resist increasing the purchase price for tax assets, such as income tax refunds, or deferred tax assets, because they do not want to effectively pre-fund tax benefits that may only be realized later.

Accordingly, it is important that the definition of working capital used in the SPA mirrors the definition used to determine the working capital peg.

Post-Closing True-Up

After closing, the buyer typically prepares a final closing statement based on the company’s actual closing balance sheet. If the final calculation differs from the seller’s estimate used at closing, the purchase price is adjusted accordingly, with the difference paid by the buyer or refunded by the seller.

To the extent that the parties cannot agree on the final closing statement, the SPA often includes a mechanism to resolve the dispute among the parties, barring which it is referred to one or more independent accountants.  Parties may also agree to a holdback or an amount held in escrow to secure payment of the downward adjustment, particularly where the closing working capital may not be accurately estimated. 

Conclusion

Purchase price adjustment provisions are among the most important economic mechanisms in a share purchase agreement because relatively small differences in definitions, accounting treatment, or closing estimates can materially affect the final amount paid for a business. For business owners considering a sale or acquisition, understanding how cash, indebtedness, transaction expenses and working capital interact in the purchase price calculation is essential. Careful attention to the definitions used in the SPA, particularly the consistency between the working capital peg and the closing calculation, can help minimize post-closing disputes and ensure that the final purchase price accurately reflects the financial condition of the business delivered at closing.