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Nov 14, 2012
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1. ®The Global October 2012Corporate AdvisorThe Corporate Finance newsletter of Crowe Horwath InternationalWelcome to the October edition of the Global Corporate Advisor(GCA) newsletter This month, Olivier Grivillers from the The GCA team is here to respond to Crowe Horwath Paris office explores your needs relating to M&A transaction the issues around valuing options used support, valuations, M&A advisory as part of executive compensation services and related services. If there packages. Options help ensure that is something you’d like to see in future executives have a clear financial issues of the GCA newsletter, don’t interest in company performance. hesitate to contact me or a member of However, they can be complex, and the team to discuss your ideas. executives, remuneration specialists Here’s hoping the year closes out and valuation experts need to strong for all of us! understand the different ways of valuing options. We also examine the challenges presented by non-core businesses. Marc Shaffer Some company managers are keen Chairman, Global Corporate Advisors to divest these business lines – email@example.com particularly if they act as a drag on the overall operations. But the process can take significant effort and planning to prepare a non-core business line for Inside This Issue: sale. Fintan Connolly, Liam Hawkswell and the Crowe Horwath team in Welcome 1 Brisbane provide their insights into this complicated subject. Valuing Options in Executive Contact Us One challenging part of any business Salary Packages 2 For further information, contact: sale is settling on a sale price. In this Getting Your Ducks in a Row: edition, Stefan Jansen from Crowe the Virtues of Preparing a Non- Marc Shaffer Horwath’s Netherlands office takes us Chairman, core Business Line for Sale 6 through two methods of calculating the Global Corporate Advisors price of target business: locked box and Getting the Price Right: firstname.lastname@example.org completion accounts. Comparing the Locked Box For your local contact, visit our and the Completion Accounts website at www.crowehorwath.net Approaches 9Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 1
® October 2012Valuing Options in Executive Salary PackagesBy Oliver Grivillers, ParisIntroduction Figure 1: How executives are compensatedCompany managers are Other miscellaneouscompensated in a variety of ways. Social advantagesAccording to a 2009 study ofFortune 100 companies, salary and 5%bonuses account for less than 50% Stock optionsof an executive’s total compensation 10%(Figure 1).Top-tier executive pay also consists 22%of significant financial instruments Bonus 24%such stock options and warrants. Thismakes it important for executives,remuneration specialists andvaluation experts to understand 23%option valuation methods. 16%In developing remuneration Other deferredstrategies, companies need to view compensationexecutives as ‘investors’. Options Basic salaryensure that executives have a clearfinancial interest in how a company Source: Financial incentives for executives, Economica (2010)performs. However, the issuessurrounding options can be quitecomplex. Figure 2: Option gain profileTo accurately value the deferredcompensation of executives,companies may need to modify their Gain Buyercurrent option valuation models– including the widely used Black-Scholes model. Options that areissued on a non-transferable basisshould have a discount appliedto their value. Based on research Premiumundertaken to date, this discountshould be in the order of 20% to 40%. Strike price Price of theThis article will cover three issues: underlying asset at maturityn valuing optionsn the Black-Scholes modeln non-transferable options valuation. SellerValuing options LossAn option is a contract between twoparties, where one party gives the This asset will be bought or sold at a Under a call option, the buyer willother the right (but not the obligation) predetermined price, called the strike experience a loss limited to the amountto buy (known as a call option) or sell price. The option can be executed of the premium if they forgo the option.(a put option) an asset in exchange during a period of time (in the case of Or they may stand to gain a potentiallyfor the payment of a premium. US-style options), or on a precise date unlimited profit (see Figure 2). (European-style options).Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 2
® October 2012Calculating the option’s value Figure 3: The value of a call optionAn option’s value comprises twocomponents (figure 3): Strike pricen Intrinsic value: this represents the Value of the option value of exercising an option now. If the price of the underlying asset is greater than the strike price, an executive can make a profit. If the Time value price of the underlying asset is below the strike price, an executive will make a loss amounting to the Intrinsic value premium price.n Time value: the current price of the Value of the underlying asset option minus its intrinsic value. Time value will vary based on movements in the price/value of the underlying n the instantaneous standard n The underlying security price: asset, and the amount of time deviation of the return on the as this price changes, so does the remaining before the option expires. underlying asset (volatility); and value of an option. For instance, as the value of the underlying assetThe Black-Scholes n cumulative standard normal distribution. rises, the value of a call option will typically increase and the value of amodel Using Black-Scholes to put option will fall.There are a number of different models determine option values n The strike price: the higher thefor option valuation, including the Cox- Under this model, there are six factors strike price, the lower the value ofRoss-Rubinstein model, the Monte that affect the price of an option. Table a call option (assuming a constantCarlo, and the most famous model, the 1 shows how call and put option prices value of the underlying asset). TheBlack-Scholes model. are affected by movements in the listed higher a call option’s strike price,The Black-Scholes model can be factors (shown by the green and red the less chance the price of theused to value simple options, such as arrows). underlying asset will exceed it.stock options and warrants. The model These factors are explained in morecalculates the possible prices of the detail below.underlying asset at maturity, and theprobabilities of these prices occurring.This is based on the fundamental Table 1: Determining movements in option pricesassumption that prices are a randomvariable with a standard normal Evolution of the factors Call option price Put option pricecumulative distribution. The Black-Scholes formula is Underlying security price complicated sets of formulas that considers: Strike price n the current price of the underlying asset; Volatility of the underlying asset n the option’s strike price; Time to maturityn the time remaining until maturity (in years); Risk-free rate n the continual annual risk-free rate (a theoretical rate of return with no Dividends or coupons risk); Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 3
® October 2012n Volatility of the underlying asset: is higher than €4.39, the gain for the Academic studies the value of both a call and a put holder will be the difference between Restricted stocks have many of the option rises with the volatility in the the underlying asset price and the characteristics of non-transferable value of the underlying asset. The exercise price (€4.39), less the option options, and many studies on these more volatile the underlying asset, price (€1.11). If the underlying stock stocks have been conducted in the US. the more likely its value will rise or price is below €4.39, the holder will lose The studies listed in Table 3 can help fall sharply. As options reward risk, the option price (€1.11) measure the extent to which stocks the greater that risk is, the greater have been discounted due to the the potential financial upside – equating to a higher option value. Non-transferable restrictions imposed.n Time to maturity: the longer the options valuation Table 3: Academic studies and stock time until an option matures, the A number of recent studies show that discounts greater the likelihood of fluctuations many stock option–based executive in the price of the underlying asset. management remuneration packages Average mainly include non-transferable stock Author Year This increased risk raises the discount* option’s value. options. The term ‘non-transferable’ US Securities means that the option is neithern The risk-free rate: is a theoretical and Exchange 1971 23% tradable nor exercisable during a rate of return on an investment with Commission certain period. no risk – generally taken to be the M Gelman 1972 33% yield on AAA-rated government As this option cannot be transferred to another party, it is worth less than a J M Maher 1976 35% bonds. If the risk-free rate rises, the value of the call option will too. classic option. R R Trout 1977 34% The further away the maturity date To value these options, the valuation W L Silver 1991 34% on a option is, the further away model must take into consideration an B A Johnson 1999 20% the payment date of that cost. The option’s non-transferability (that is, the holder of a call option will thus have option holder has to deal with a liquidity *The price gap between a non-restricted stock and a restricted stock. a cash advantage that depends on constraint on the financial instrument) the level of the risk-free rate. and the option’s non-exercisabilityn Dividends or coupons: the (the option holder suffers from an A 2001 study by Brenner examined the payment of a dividend or coupon opportunity cost during the period the impact of non-transferable exchange lowers the value of the underlying option cannot be exercised). options on the Israeli money market. asset. This lowers the value of a call The options were issued by the Israeli The studies below show how the non- central bank, the Bank of Israel, and option and raises the value of a put transferable nature of some options option. were not transferable before maturity. affects their value.In this example (Table 2), an investor These options were compared to Accounting approach similar options issued by commercialpays €1.11 today for the right to buya share at €4.39 in seven years time. International Financial Reporting banks and negotiated on the financialThis share is currently worth €3.92. In Standards 2 (IFRS 2) does not always market. The non-transferable optionsseven years, the underlying stock price consider the non-transferability of the traded at a discount of around 20%will be worth between zero and infinity option valuation from an accounting over the options issued by commercialEuros. If the underlying stock price point of view. However, it does take into banks with six months of maturity. account the effect of the early exercise Empirical studies of options in accounting valuations. TheTable 2: Example of a call option impact of this is to decrease the time Another study was conducted on the value of the option. The decrease in the French warrant market. In particular, Underlying asset’s price it looked at the restricted capped 3.92 total value of the option depends on the (in €) warrants issuances that took place option’s maturity, and can vary between Strike price 4.39 20% and 40%. between 2008 and 2010. The non- transferability discounts observed are Time to maturity (in days) 2,555.0 shown in Table 4. Volatility as a % 25.0 Risk-free rate as a % 3.97 Dividend rate as a % 0.80 Value of the call 1.11Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 4
® October 2012 Olivier Grivillers is one of five authors of Financial Incentives for Executives, Economica (2010). This book deals with option valuation issues for executive compensation packages.Table 4: Non-transferability discounts in French warrants Discount levels observed by operation BSAAR (warrant) Non-transferability Non-transferability Date Issuer maturity (in years) period (in years) discount (in years) December 2010 Aedian 7 2 30.5% June 2010 Mersen 7 2 29.0% May 2010 Eurofins 7 2 32.5% October 2009 Monsieur Bricolage 5 2 29.5% September 2009 Ausy 7 2 32.3% July 2009 Orpéa 6 2 28.8% April 2009 Bonduelle 7 1.5 25.0% December 2008 Overlap Group 7 2 34.0% October 2008 Nextradio TV 5 2 30.0% August 2008 STEF-TFE 7 2 34.0% July 2008 Keyrus 6 2 20.0% June 2008 Assystem 7 2 24.6% May 2008 LVL medical 7 2 20.9% January 2008 Akka Technologies 5 2 32.0% January 2008 Proméo 7 2 19.3% January 2008 Espace production 7 2 25.3% Median discount 30.0%Source: Transaction note available on the Autorité des Marchés Financiers (French financial markets authority) websiteFor more information:Olivier Grivillers is a Partner at Horwath Audit in France. He can be reached at +33 1 4105 9848 or email@example.com.Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 5
® October 2012Getting Your Ducks in a Row: the Virtues of Preparing aNon-core Business Line for SaleBy Fintan Connolly and Liam Hawkswell, BrisbaneCompanies face many choices around n What return to the buyer will the Divesting business lines that make awhat to do with non-core businesses. If business line provide, either as a significant contribution to companythese lines are underperforming, they stand-alone business or bolted on value and profits will invariably have amay drag on the overall operation’s to a buyer’s operation? negative impact on valuations.success by diverting limited resourcesand distracting management attention.In some cases, it may be time to sell n Is the business more valuable to a potential buyer than to the How can wethese divisions. seller? Are there any likely target buyers for the business line, and maximize the saleHowever, management should not rush what potential synergies could price of a businessto sell non-core businesses. It takes they derive from the acquisition/careful effort and planning to get a non- purchase? line?core division ready for sale. Vendors The key consideration in determining n Does the business line have growthneed to be prepared for a potentially the sale price is often whether another potential?complex and involved sale process. As party can obtain greater value fromChinese philosopher Sun Tzu said: “To n Are there any external factors your non-core business line than your... not prepare is the greatest of crimes; that may adversely affect the sale company can. This is what makes ato be prepared beforehand for any of the business line, including business line attractive to others.contingency is the greatest of virtues”. negative perceptions of the industry, regulation and the threat of Clearly explaining historical andThis article – targeted at private andlisted businesses – explores three litigation? forecast financial performanceoverarching questions the management Ensuring the non-core business Prospective buyers of your businessof corporations (‘sellers’) should line will typically consider its historical line can stand aloneconsider when deciding whether and forecast financials to determine Potential sellers must make sure the its true value. As such, managementto divest a non-core business (the business line can be successfully needs to make sure prospective‘business line’): carved out of their operations. In some buyers:n Is the business line truly non-core? cases, a revised operating structure or business model will be required if n understand the historicaln How can we maximize the sale performance of the business line the business line is removed. Further, price? additional infrastructure may be n receive clear projections aboutn How do we create an efficient sale required to effectively support and future financial performance process? manage this business line once it is separated (e.g. management and n are informed of any discrepancies inIs the business line accounting systems). the historical financial performance that are not reflected in forecasts.truly non-core? Weighing up the potential This includes explaining how proceeds of the sale adjusted profit is calculatedTo answer this question, management A seller needs to have an idea of how historically, and how this has beenneeds to drill down and consider the the sale of a business line will affect used as a basis for forecasts.business line in the context of thecompany’s overall operations. To its capital position. In the case of a Developing a clear financialdo this effectively, we recommend listed company, how could the sale modelmanagement uses the following of a business line and its capacity to generate value and profits affect the Using financial models can help sellersdivestment checklist: core business’s valuation? Further, and prospective buyers determine then What is our core business? does the business line generate value potential future growth and profitability in its capacity to produce profits and of the business line. Detailed analysisn Is the business line integral to the assist the seller’s other business lines is required to ensure all underlying core operations? in creating shareholder value? drivers are identified and capturedn Do the costs associated with within models. carving out these operations outweigh the potential benefits?Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 6
® October 2012To develop an effective financialmodel, sellers also need to define the How do we create Understanding likely tax and legal issuesassumptions that underpin the businessline’s financial projections across the an efficient sale Sellers should also address any taxareas of revenue, expenses, working process? and legal implications arising from the sale of a business line, includingcapital, financing, capital expenditure To ensure the sale of a business line understanding:and balance sheet. proceeds as smoothly as possible, n tax/deferred tax liabilities which mayWhen preparing a financial model that management needs to understand the be trigged by the transactionprojects the performance of a business type of information potential buyersline, a number of ‘normalizations’ require, and have this information n the terms of existing legalwill need to be made to the historic readily available. commitments, such as employeefinancial performance of the business contracts and bank loan covenantsline. The process of normalizing Complete a sell-side due diligence report n likely contractual commitmentsprojected financials involves identifying of the seller, that the buyer mayincome and expenditure items that Commissioned by the seller, this report require the seller to maintainwill be irrelevant to the business line, identifies issues potential purchasers for a period after the sale (e.g.and which are unlikely to re-occur or may have with a business line, allowing warranties and undertakings, suchcontinue post-sale of the business line the seller to prepare for and mitigate as a commitment by the seller that(e.g. the writing off of a bad debt). It against such problems. In addition, there are no undisclosed liabilitiesis important to identify and properly the report may highlight the business’s for which the buyer of the businessexplain these normalizations when potential strengths and opportunities, could become liable).preparing the financial model. which can be used to the seller’s advantage during the sale process. Prior to undertaking a sale process,Dealing with financial and other sellers should also ensure that existingrisks Establish a data room legal documents are reviewed andTo perform well during the sale process, A data room is a physical or virtual up to date, such as shareholdersellers need to identify and resolve any space where a potential purchaser agreements, company constitutionsissues before prospective buyers raise can access the key documents of and share registers. These documentsthem. There are a number of ways a transaction target, including legal will typically be included in the datasellers can do this, and build the value documents, accounting information, room.of a business line, such as: and client or customer details. This information can be provided in the Set up separate accountingn hiring key management for the form of printed documents or through infrastructure stand-alone business line an online facility. Generally, the lead Sellers may also need to separate then restructuring to eliminate overhead advisor to the sale process will help the accounting information of the business costs seller set up a physical or electronic line from its main operations. This data room. can make it easier for sellers to meetn resolving outstanding disputes (if Having a well-prepared data room is an the information requests of potential any) essential element of every competitive buyers, who will require separaten ensuring the business line will have sale process. The data room allows accounting records for the non-core its own legal agreements in place the seller to make sensitive information line – typically going back at least (transferred/assigned or newly available to potential buyers in a three years. Further, the presence of entered into/novated) to properly controlled environment. This is separate accounting records restricts function after its sale (e.g. customer particularly important when multiple the ability of potential bidders and and supplier agreements) buyers exist. competitors to access information about the core business.n identifying intellectual property that is required by the business line and ensuring it is properly licensed to/ owned by the business line.Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 7
® October 2012Avoiding traps in Understand your potential buyers Your choice of broker, accountant, lawyer and lead advisor will affect thethe sale process It is important to prequalify potential efficiency and outcome of any intended transaction. Meeting with your advisorsNo two sale processes are the same. buyers before commencing the sale as early as possible can help you planNegotiations over companies and process. The seller and its advisors and identify issues, and leave enoughassets can vary greatly between single- should carefully select potential bidders time to effectively resolve problems.and multiple-party negotiations, and to avoid ‘tire kickers’ and fishingauctions. expeditions by competitors. It’s always a good idea to ask your advisors to explain how theirTo avoid management becoming In some instances, the seller may want experience and expertise is relevant todistracted during the sale process, it to keep the sale process confidential. your business line and its planned sale.may be useful for sellers to identify a One way to do this is to useseparate management team for the confidentiality undertakings and non- Complete the sale process withinnon-core business line, which can disclosure agreements. Because the a defined timeframeoperate independently of the core seller will be exchanging commercially A structured sale process requiresbusiness. This will help ensure that sensitive information with potential careful planning. It should includethe core business does not lose key competitors, these measures can help agreed timelines and the requirementmanagement in the process of sale, minimize the risks associated with a for a non-binding offer (for the purchaseand that the business line being sold breach of confidentiality. of the business line) to be lodgedwill be adequately staffed to operate on Choose your advisors carefully before due diligence takes place.a stand-alone basis in future. Sellers should seek expert advice When entering any negotiation, youThis step also ensures that the before contemplating any corporate need options in case the sale processoperational performance of the non- transactions, whether they relate to does not unfold as planned. You alsocore business line is closely monitored shares, assets, undertakings or capital need to be prepared to walk away fromso that the core business does not raisings. the deal if necessary.suffer during the sale process. Thisalso ensures resources are efficientlyallocated.For more information:Fintan Connolly and Liam Hawkswell are part of Crowe Horwath’s Brisbane team.Peter Bishop is Lead Principal in Crowe Horwath’s Corporate Finance team in Brisbane. He can be reached at +61 7 3233 3505or firstname.lastname@example.org. Fintan is an Associate Principal with Crowe Horwath Brisbane’s Corporate Financeteam. He can be reached at +61 7 3233 3402 or email@example.com.Audit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 8
® October 2012Getting the Price Right: Comparing the Locked Box and theCompletion Accounts ApproachesBy Stefan Jansen, NetherlandsWhen a business is sold, vendors and maximizes value. This makes it price, and no completion accountsbuyers must agree on a purchase important for buyers and sellers to be or completion audits have to beprice. This price is often based on aware of the issues surrounding each undertaken. This can prevent disputesearnings multiples or cash flow– approach. over the purchase price and reducebased valuations, and adjusted for transaction costs. This article also discusses thefactors such as debt and working relationship between an initial business Managing leakage in locked boxcapital. However, the true picture of valuation and the final sale price. transactionsa business’s financial position canchange between when a buyer agreeson a price and signs the deal, and The locked box However, because there is no adjustment process, the parties needwhen it takes control of the company. method to address the potential for value to ‘leak’ out of the business betweenAs a result, both buyers and sellers A locked box transaction calculates signing the deal and its completion.should take steps to protect their the value of a business based on These leakages include managementposition and maximize value. This its balance sheet at a certain point payments, dividends and bonuses.article looks at two common methods in time. The price of the business is Buyers will likely request covenants,for calculating the price of a target ‘locked’ from this date, and there are indemnities and warranties to guardbusiness: locked box and completion no adjustments after the deal has against this situation.accounts. been completed. A buyer assumes all economic ownership, risks and rewards Of course, some leakages, such asIn theory, these two methods should from the locked box date. wages, are unavoidable in the normalarrive at a similar value for the operation of a business. So buyersbusiness. But in practice, the choice The advantage of this approach is and sellers should agree on a list ofof method can affect which party that it gives buyers and sellers a fixed permitted leakages. And a buyer must receive assurances that the seller will run the business properly between theFigure 1: Completion accounts and locked box locked box date and deal close. Completion accounts Signing Determination of Reference date Covenants of conduct purchase price Agreed valuation/Working capital Completion accounts Anti-leakage covenants (locking the box) Determination of purchase price Closing Locked box Economic ownership: Seller Economic ownership: BuyerAudit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 9
® October 2012A particular issue can arise when a As the global financial crisis began, worked example below (Figure 2). Webuyer intends to acquire a business use of the locked box method will discuss the factors of bridging valuethat needs to be carved out from a declined sharply as buyers sought to price, and positive and negativelarger entity. In this case, it may be protection against exposure to risk. valuation adjustments.hard for a buyer to identify the leakages (The locked box method traditionallyspecific to the individual business line. favours sellers, as they can lock in Bridging value to price a fixed purchase price and limit their In this example, a buyer has valuedIn a locked box transaction, parties its target at US$27 million (the downside risk.) However, duringusually agree on a fixed period where enterprise value). This value has 2009 locked box transactions rosea buyer can raise leakage claims. This been reduced by US$3 million due to in popularity, especially in France,period can be as short as a couple of valuation adjustments, which include Germany, Belgium, the Netherlands,months, and is typically shorter than a unrecognized pension liabilities and and Luxemburg due the rebound inwarranty period. adjustments to earnings. confidence in these economies.The completion Key considerations Further, after the accounts have been closed off, differences mayaccounts method in pricing arise between the pricing parameters negotiated during the deal and theAn alternate approach is to allow theparties to agree on a purchase price approaches actual amounts. These adjustments – sometimes referred to as the ‘equitythat is subject to adjustments after the There are a number of important bridge’ – mostly relate to net debt,deal has closed. This is known as the considerations for buyers and sellers working capital and capex adjustments.completion accounts method. in determining a final purchase price They are grouped together asThe final purchase price will include an on a business sale. For instance, a ‘Adjustments finalized at completionadjustment to take into account factors buyer wants to know that the target’s accounts’ in Figure 2.such as cash, debt, working capital and financial statements are reliable andassets. The precise factors will depend valid. Under either approach, a buyer is Positive valuation adjustmentson the sale and purchase agreement paying a price based on the business’s In this example, cash and currentnegotiated between the two parties. value at a particular date. So it requires working capital balances add positively access to management to identify any to the enterprise’s value. For cash,One issue with this method is that pricing or resource issues. the assumption is that cash balancesit can involve protracted talks – and In addition, a seller must ensure that, are not trapped. Cash can be trappeddisagreements – between buyers and regardless of the pricing approach, the where restrictions exist on remittancessellers over the final purchase price. business’s financial position is accurate back to the parent company’s country.This could mean the ultimate price is and will not lead to a buyer resorting In this situation, a buyer would discountnot determined for months. to litigation. The seller may also need the value of the cash on the balanceThe differences between locked box to produce sound financial information sheet.and completion accounts are shown in in short timeframes – includingFigure 1. Negative valuation adjustments in potentially complex carve-out situations. A business’s valuation will be draggedContinuing Further, as part of a transaction, a seller down by debt, shortfalls in the required level of working capital and unplannedpopularity of may request a buyer pays interest on the equity value of a company, as it spending.the locked box only receives payment after closing In this example, working capital totals US$2.8 million on closing, whileapproach off the accounts. In a locked box deal, a buyer is entitled to the benefits of normalized working capital is valued owning the business after the locked at US$3 million. The buyer subtractsTypically, completion accounts have box date, and so it usually makes US$200,000 from the company’s valuebeen seen as a way for a buyer to interest payments on the equity value as this amount must be invested by theprotect its financial position during a of a company to the seller. purchaser to maintain required levels oftransaction. This is because the buyer working capital.has recourse to negotiate an adjustedpurchase price after the deal is closed. Deal example: The working capital mechanism isDespite these advantages, industrysources suggest around 50% of merger equity valuation based on a target working capital amount that a buyer intends to acquireand acquisition transactions use the To understand how the value of in a deal, assuming that this amount oflocked box method. a company relates to its eventual working capital is sufficient to operate purchase price, we have provided a the business. Any deviations from theAudit | Tax | Advisory www.crowehorwath.net©2012 Crowe Horwath International 10
® October 2012Figure 2: Equity valuation $40,000 $4,500 $30,000 $2,800 USD’000 $20,000 $3,000 $6,000 $3,000 $500 $27,000 Valuation adjustments $21,800 $10,000 Adjustments finalized at completion accounts $- Enterprise Valuation Cash and Debt Working Working Capital Purchase value adjustments cash capital on capital spend vs. price equivalents closing normalized budgettarget amount of working capital will n capex mechanism: which is used increase in net working capital, but itlead to adjustments in the purchase to control investment spending does not take into account the negativeprice. between the signing and closing of impact on the debt position. In this a deal. way, it allows a seller to manipulate theThe working capital mechanism should purchase price.be used in conjunction with a: By using these mechanisms, a seller can protect its balance sheet position Further, in the example, the buyern net debt mechanism: which adjusts right up to the close of a deal. For needs to include US$500,000 for the purchase price for differences in example, if a net working capital delayed expenditures. Together, all actual net debt position compared mechanism is applied without a net these adjustments mean the purchase to the target net debt position debt mechanism, a seller could pay price is calculated at US$21.8 million. all its creditors. This would lead to anFor more information:Stefan Jansen is a manager at Crowe Horwath Corporate Finance, the Netherlands. He can be reached at +31 24 372 5469 firstname.lastname@example.org. Regional GCA Leadership China & Hong Kong Indian Subcontinent / Middle East Southeast Asia Delores Teh Vijay Thacker Alfred Cheong email@example.com firstname.lastname@example.org email@example.com East Asia Latin America USA / Canada Mok Yuen Lok Roberto Pérez Marc Shaffer firstname.lastname@example.org email@example.com firstname.lastname@example.org Eastern Europe Oceania Western Europe Igor Mesenský Andrew Fressl Peter Varley email@example.com firstname.lastname@example.org email@example.comCrowe Horwath International is a leading international network of separate and independent accounting and consulting firms that may be licensed to use “Crowe Horwath” or “Horwath” inconnection with the provision of accounting, auditing, tax, consulting or other professional services to their clients. Crowe Horwath International itself is a nonpracticing entity and does notprovide professional services in its own right. Neither Crowe Horwath International nor any member is liable or responsible for the professional services performed by any other member.Audit | Tax | Advisory©2012 Crowe Horwath International 11