Why we need Completion Adjustments Workout
- 03:48
Why we need Completion Adjustments Workout
Transcript
So in this workout we're taking a look at a transaction where A acquires B, and A is bidding 1,000 for all the shares of B, and the shareholders have accepted. Now at the announcement, the target company, which is B, had debt of 200, cash of 100, and working capital of 50. Now under scenario A, at closing, so remember when you agree the transaction, that's gonna be before the completion date, debt is 300, cash is 100, and working capital is 50. So the cash and working capital has stayed the same, but the debt has increased. So if we just take a look at the original equity value which we were told is 1,000, and I'm just going to make that blue, then we're going to add the debt to that, and we're going to subtract the cash from that. And then we'll get the enterprise value at the announcement date. And we're gonna assume that the enterprise value doesn't change because that's the value of the business. But at the closing we've got debt of 300, so what I'm going to do is I'm gonna subtract because I'm reversing the equity to enterprise value bridge, subtract the debt. But I'll add the cash 'cause we're going to now calculate the equity value. And I'll just sum up that to get my equity value. And you can see here the equity value is 900. So this means that what's happened is that the vendor who's selling the business obviously has paid themselves a dividend or something financed by debt, because the debt in the business has gone up, but there's not been a corresponding increase in cash. So this is one of the key things that you need to worry about between agreeing a price and then at closing, the numbers changing. This is why we need to understand actually what the debt and the cash numbers are at closing, because really in this case, the acquirer should be paying less for the business, 900 rather than the original agreed 1,000. So the lawyers would make this adjustment and reduce the equity value paid. Let's take a look at another scenario. And we've got a scenario here where debt is now 200 at closing, cash is 150, and working capital is 50. And we're gonna assume there's no differences to working capital here. So if we take the original equity value of 1,000 again, because that was what was agreed at closing, and then what we will do is we'll add on the debt at the announcement date and we'll subtract cash, which will give us our enterprise value, which is 1,100. But the closing debt here, if I subtract it, is 200. And then I'll add the cash, that of 150, and then I can calculate the equity value at closing. Now here you can see the equity value is higher, and this is because the business has probably generated some earnings which have turned into cash because the cash balance has gone from 100 to 150, but debt has stayed the same, and the working capital has stayed the same. So there's more cash in the business, and it's more valuable. So again what the lawyers should do is say actually the cash balance in the business at closing was higher than what we had originally anticipated, so therefore you need to pay more. So these are examples of what closing adjustments that need to happen to correct for the fact that what we expect the debt and the cash to be at closing isn't necessarily what actually are the balances. And that's why we need detailed completion adjustments.