In this blog, I use an experience with a real estate client but this important point applies to all businesses.
One of my real estate clients received a letter from its largest tenant saying they were due $160,000 CAM (common area maintenance) refund. I read the lease which was 20 years old and interpreted the CAM language differently. My calculation said the tenant owed us, not the other way around. Long story short, my calculation was enough to bring the tenant to the negotiating table and not only did we not pay them the $160,000, but we signed them to a $9 million lease extension.
Here’s the point. Lawyers wrote the lease but not being accountants, their formulas were vague and subject to interpretation. Accountants are the ones who must do the actual computations when the time comes and thus, should be involved in drafting financial formulas and terminology that go into agreements in the first place.
Precision in financial formulas and language are also essential in earn-out agreements where the seller of a business agrees to be paid additional sales price in the first years following the sale of their business. Earn-outs are usually a multiple of earnings in those years so how the earnings and earn-outs will be calculated must be crystal clear.
When a client of mine sold their business, I was so familiar with their numbers I took the lead in structuring the earn-out language and formulas and I was very precise, leaving nothing to chance.
I put the formulas with the numerous addbacks and subtractions to earnings that the parties had agreed to into an Excel spreadsheet so that the parties could see the actual calculation as it would occur post-closing. They agreed to my spreadsheet and made it an exhibit to the purchase and sale agreement. When it comes time to compute the first and subsequent year’s earn-outs, they’ll follow the spreadsheet and there will be no dispute.
Also, instead of narratively describing the formula in words, the actual formulas should be put in an Excel spreadsheet and made part of the exhibits in the agreement. That way there can be no ambiguity or controversy when it comes time to run the actual numbers.
Finally, a CFO should devise the exact financial formulas and language that’s intended by the parties.
I hope this helps. If you need help with your next agreement, I offer my assistance.
You can reach me at (305) 467-5909 or at reb@robertband.com.