Buying a Business in the U.S., Part 6: Purchase Price Adjustments

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When a buyer and seller agree on a purchase price for an acquisition, the sticker price on a term sheet is rarely the payment that changes hands. Between signing the deal and closing (and often, even after closing), a series of contractual adjustments will dictate what the seller actually receives, and when.

In U.S. private M&A, pre-closing adjustments do most of the work, starting with working capital, cash and indebtedness, and unpaid seller transaction expenses. After closing, earnouts (and other contingent consideration) as well as indemnity adjustments are also common.

Understanding how all of these up/down levers fit together is essential for anyone negotiating or evaluating a deal. Purchase price adjustments will alter the economics of a deal, sometimes wiping out a sizeable chunk of the seller’s expected proceeds, or forcing a buyer to overpay. This is especially true in lower-middle-market transactions (typically under $25MM in enterprise value).

Does this mean that adjustments should be minimized or avoided? No. The logic for including them is often compelling for buyers and sellers alike. Adjustments help to minimize uncertainty, and they ensure that the price being paid for a business is as close as possible to its value. They bridge the gap between the idealized valuation of a business and its real-world closing condition.

Working capital

Working capital is the most common transaction adjustment, and often the most heavily negotiated. We see this adjustment in nearly all deals. It exists because a business cannot operate without a certain amount of liquid assets and accounts: inventory to sell, receivables to collect, and payables to manage. The value of each of these items will fluctuate (often on a daily basis) between the signing and closing of a deal.

Buyers will initially price a deal expecting the target to with a certain level of operating liquidity. This is commonly called the "target amount” or similar. If the company actually arrives with more working capital than the target amount, the seller benefits, and the price increases dollar for dollar. If it arrives with less, the buyer recoups the shortfall through a downward adjustment.

The negotiation here is less about the principle than about the specific terms, especially in asset heavy businesses. And specific terms are key. What counts as working capital? Which accounts are included? What accounting standards apply? Is that inventory buildup a genuine operating asset, or is it immovable stock? Are all of those receivables actually collectible? Etc.

The answer to each of these questions can swing an adjustment, often significantly, which means both sides have strong incentives to define the terms in their favor. A buyer who defines working capital narrowly may capture items the seller believed were excluded; a seller who lumps in non-operating assets may find the buyer deducting those assets from the adjustment.

The mechanism usually works in two steps. Before closing, the seller prepares an estimated closing statement, which the parties use to set the amount exchanged at closing. After closing (typically within 60 to 90 days), the buyer prepares a final statement measuring the same items as of the closing date. The difference between the estimated closing statement and the final figures produces a true-up, or an additional payment to the seller or a repayment to the buyer.

Cash and indebtedness

If the valuation assumes the buyer is acquiring a business without excess cash, then any cash left in the target at closing should be added back to arrive at the equity price. The adjustment seems simple: count the cash, then add it to the purchase price. In practice, it may not be so simple. What qualifies as "cash"? Only unrestricted bank balances? What about prepaid amounts, and customer deposits that function similarly to cash? The parties must draw the line precisely, because cash definitions interact with working capital definitions. An item classified as cash cannot also be counted as working capital, and vice versa.

On the other side of the ledger, any debt the target carries at closing reduces what the seller receives. Like cash, indebtedness sounds self-explanatory, but rarely is. The definition may extend beyond borrowed money to include debt-like items: earnout obligations, accrued bonuses, deferred revenue, or unpaid taxes. Whether a particular item is classified as debt, working capital, or an expense is often negotiated. The ultimate classification determines whether it reduces the price, affects the working capital adjustment, or is simply paid separately.

Seller transaction expenses

The final common adjustment accounts for deal costs a seller is responsible for, but has not yet paid at closing. Advisory fees, legal fees, financial printing, and similar items are usually deducted from the price the seller receives. The idea is that the seller should bear the cost of the professionals who advised the seller, not the buyer. This is a more “straightforward” adjustment as far as things go, and is often paid out at closing.

Earnouts and other contingent consideration

Earnouts are a related but distinct consideration that deserve special mention. Earnouts make additional consideration contingent on future business performance. Performance can be tied to any number of metrics, but revenue targets, earnings and client retention are typical categories.

An earnout is not a closing adjustment; instead, it measures what happens after closing. This distinction matters legally. A working capital adjustment is a mechanical calculation performed once, based on a snapshot of the business at a specific moment. An earnout is a forward-looking bet that requires ongoing measurement, disclosure, and often a separate dispute process.

In smaller business sales especially, the earnout may be tied to a consulting agreement for one or more of the seller principals, and may involve non-competes. Purchase price adjustments determine the final purchase price. Earnouts, escrows, holdbacks, and indemnification provisions are different mechanisms, but they also determine how much of that price the seller ultimately receives and when.

Indemnity holdbacks and escrows

Indemnities are provisions where the seller compensates the buyer for specific losses or liabilities that arise after the transaction closes due to breaches of seller representations or warranties. These provisions are another risk allocation mechanism, ensuring that the buyer does not bear the financial burden of undisclosed or misrepresented liabilities.

With an indemnity holdback, a portion of the purchase price may be placed in escrow or simply held back by buyer for a specified period post-closing. The holdback amount exists to cover potential indemnity claims. If an indemnified loss occurs, the buyer can seek recovery from the escrowed or held back funds rather than pursuing direct claims against the seller. This provides an immediate and liquid source of funds to satisfy indemnity obligations.

Some sale agreements will also require the purchase of representations and warranties insurance (RWI) by a seller. RWI can either supplement or replace traditional indemnity structures by covering losses resulting from breaches of representations and warranties, reducing the need for large holdbacks or escrows. However, RWI policies typically include exclusions and deductibles, meaning certain claims may still require direct indemnification from the seller. In lower-middle-market transactions, most buyers will focus more heavily on holding back funds than requiring RWI.

Why purchase price adjustments matter

Purchase price adjustments are where much of the real negotiation happens in private M&A. Again, the headline number is not the deal. Negotiations on these key levers happen within the body of the purchase agreement. They may also evolve continuously after a term sheet is signed—especially if there are unexpected findings in due diligence.

Sometimes, buyers have an advantage in setting the rules of engagement here. It is customarily the buyer's counsel who drafts the initial form of purchase agreement. A savvy buyer will insist on adhering to that process, and include that requirement alongside each category of desired purchase price adjustment in the term sheet kicking off a deal.

For earlier posts in this series, check out the following: