Effects on the indemnification clause of applying a ‘multiple’ for share pricing
In acquisition agreements, the value of a company is often based on a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or another parameter.
If, in retrospect, the communicated figures appear to paint an overstated picture of the company, the indemnification mechanism will usually provide for compensation at a rate of EUR 1 in damages for each euro in deviation of the communicated net equity (or another formula whereby the adapted price equals the established lesser value).
However if the correction involves a parameter to which a multiple was applied for price determination purposes, then that same multiple should be applied to the indemnification mechanism.
Here’s an example:
An acquisition agreement states that the share price equals 5 x EBITDA, or the price was in fact calculated that way.
A few months after the acquisition, the buyer of the company finds that the seller of the shares has in fact understated the staff costs in the balance sheet that served as the basis for the valuation of the shares.
The buyer of course seeks compensation for the damage arising from the understated value.
However, the damage is not limited to the staff costs times one.
Since the buyer paid five times the company’s EBITDA value for the shares, the impact of the undervaluation of the staff costs on the share price equals five times the amount of the undervaluation.
If the acquisition agreement between parties does not state explicitly that in the event of an infringement of the representations and warranties, the compensation will amount to five times the damage incurred by the company, but instead – as is often the case – contains a provision that one euro in damages for the company shall equal one euro in damages for the buyer, the latter will be able to recover only one fifth of the damage incurred.
Coralie Mattelaer, intui attorneys