The Law Offices of Paul H. Appel – Your Trusted Business Law Partner in New Jersey
Mergers & Acquisitions · Valuation
An appraisal or broker's estimate produces a number. The purchase agreement decides what that number buys, what gets deducted from it at closing, and how much of it the seller is paid now rather than later.
Valuation and the lawyer's role
Valuation is financial work, done by accountants, appraisers or brokers. The legal task is translating a valuation into price terms that hold up when the closing statement is prepared.
Buyers and sellers usually arrive with a figure in mind, often based on a multiple of earnings, a review of comparable sales or an appraiser's report. That figure is a starting point. Before anyone can say what the seller will actually receive, the parties have to agree what the figure assumes: whether the business comes with its cash and debts, how much working capital must be left behind, and which of the seller's personal expenses really disappear after the sale.
Paul does not prepare valuations. He works with the client's accountant or valuation adviser and makes sure the agreement reflects the assumptions behind their numbers. The firm's general business valuation guidance covers valuations for buy-sell agreements, partner exits and planning; this page is about valuation in the context of a purchase, part of the firm's work on buying and selling New Jersey businesses.
The basic bridge
Valuations of operating businesses are usually expressed as enterprise value: what the business is worth as a going concern, before considering how it is financed. What the seller receives is closer to equity value, which is enterprise value adjusted for the business's debt, cash and working capital on the closing date. Purchase agreements commonly bridge the two with a price stated on a cash-free, debt-free basis, then adjusted.
In an asset purchase, many of these items are handled by simply excluding them from what the buyer takes. In a purchase of shares or membership interests, the entity's balance sheet comes along, so the adjustments do more work. The firm's comparison of asset and stock purchases explains why that distinction matters.
Where values move
Add-backs
Sellers often add back owner perks, one-time costs and above-market family salaries to show higher earnings. Buyers test each one. Where the price relies on add-backs, the seller's representations about the financial statements become more important, and a buyer may seek specific protection for them.
Working capital
A working capital target, often based on an average of recent months, prevents a seller from collecting receivables and letting payables pile up before closing. The definition of what counts as current assets and liabilities needs to be precise, and a short post-closing true-up process should be built in.
Concentration
Heavy dependence on one customer, one supplier or the owner's personal relationships may not change the headline valuation, but it often changes how the price is paid, for example through a holdback or contingent payment.
Assets
Equipment that is leased, intellectual property owned by the seller personally, or real estate held in a separate entity can change value considerably. Diligence confirms what the buyer is getting.
Valuation gaps
When the buyer's and seller's numbers do not meet, the gap is usually closed by changing how the price is paid rather than the price itself.
| Source of the gap | Common contractual response |
|---|---|
| Seller expects growth the buyer will not pay for yet | An earnout tied to post-closing results |
| Buyer cannot finance the full price | A seller note for part of the price |
| Uncertainty about a specific liability | A targeted escrow or specific indemnity |
| Value depends on the seller staying involved | Transition or consulting agreement, sometimes with retention payments |
| Doubt about the reliability of add-backs | Stronger financial-statement representations and a longer survival period |
Each of these tools has its own drafting issues. See the firm's pages on earnout provisions and seller financing for more.
Questions
Usually not. Valuations typically describe the business's enterprise value. The seller's proceeds are what remains after the purchase agreement's adjustments for debt, cash, working capital, transaction expenses and any escrow or deferred payments. Two deals at the same headline price can produce very different amounts for the seller at closing.
It is a mechanism that compares the business's working capital at closing with an agreed target and adjusts the price up or down by the difference. It stops either side from gaining by changing collections or payments just before closing. A preliminary estimate is used at closing, followed by a final calculation and a short dispute process afterwards.
A seller's valuation, or a broker's estimate prepared for the seller, is useful information but was prepared for the other side. Buyers generally benefit from their own accountant's review of the financial statements and the add-backs behind the number. The purchase agreement's representations then provide contractual protection if the financial information proves inaccurate.
When the parties disagree about future performance, an earnout lets part of the price depend on results. When they agree on value but the buyer cannot fund it all at closing, a seller note defers payment without making it contingent. Some deals use both. The choice affects the seller's risk and should be modeled with your accountant.
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