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the initial submissions, the parties typically have an opportunity to provide rebuttal submissions. In most cases, the sole purpose of rebuttal submissions is to provide each party an opportunity to provide rebuttal arguments and accompanying supporting documentation in response to the positions of the other party as presented in their respective initial submissions. Rebuttal submissions are generally not intended to facilitate the raising of new issues. It is not uncommon for parties to abandon (concede) some of their positions in their rebuttal submissions based on the support provided with the opposing party's initial submission.

      After receiving the initial and rebuttal submissions, the independent accountant will, if necessary, issue document requests and interrogatories that include questions for the parties. In some proceedings there can be multiple rounds of arbitrator document requests and/or interrogatories based on the nature and complexity of the disputed items and the information already provided by the parties.

      In addition to written submissions and the accompanying supporting documentation, there can be a hearing before the accounting arbitrator. If the parties elect to have a hearing, it is typically a one‐day event consisting of presentations from both sides and an opportunity for the arbitrator to ask questions in person.

The Arbitration Award

      After analysis of the information provided by the parties and in accordance with the terms of the applicable purchase agreement, the independent accountant provides the parties with a determination for each of the disputed items in the agreed‐upon level of detail (the “award”). In practice, the award can range from a one‐page schedule to a fully reasoned award report that incorporates a detailed discussion of the independent accountant's considerations in support of his or her conclusion. In addition to decisions on the individual disputed items, the award can also include a calculation of the impact on the purchase price and an allocation of the fees and expenses of the independent accountant between the parties. The parties can preemptively provide for the type of award in the purchase agreement or, as commonly occurs, they can decide on it later in the process, for example, at the time of the retention of the accounting arbitrator.

      A key aspect for an appropriate resolution of a post‐closing purchase price dispute is for the parties, their advisors, and the accounting arbitrator to understand the specific mechanics and requirements for preparing the final closing statement including the net working capital (or other purchase price adjustment trigger).

      Purchase agreements vary and often contain transaction‐specific provisions that may include, for example, non‐GAAP measures for specific items. The arbitrator and the parties should be careful to closely observe the provisions of the purchase agreement that governs the transaction at hand in presenting and reaching a determination regarding the disputed items.

CHAPTER 3

      Post‐Closing Net Working Capital Adjustments

      At a basic level, a company's net working capital is the difference between its total current assets and its total current liabilities. In summary, current assets are cash and other assets that are reasonably expected to be realized in cash, sold, or consumed during the normal operating cycle of the business.2 Current assets include items such as accounts receivable, inventory, and prepaid expenses. Similarly, current liabilities include short‐term liabilities such as accounts payable, accrued liabilities, and the current portion of long‐term debt. In essence, net working capital is the short‐term capital available to be used by the business in its day‐to‐day operations.

      For purposes of many valuation analyses, the analyst considers whether the company has sufficient working capital to operate its business. If the company has a shortfall of or excess working capital, an adjustment needs to be made to the value of the company. Such adjustments can have a dollar‐for‐dollar impact on the valuation.

Example: Comparative Valuation Impact

      ◼ Company A and B are identical. Company A has sufficient working capital to operate its business (no excess or shortfall). Company B has the same amount of working capital and in addition has a bank account with $1 million in surplus cash (i.e., excess working capital).

      ◼ The value of Company B is $1 million higher than Company A as the buyer could buy Company B, extract $1 million, and end up with the same company as if the buyer had purchased Company A.

      ◼ Note: The example is simplified and ignores possible complications such as adverse tax effects. Moreover, excess cash is – in practice – not necessarily transferred with the company but may be extracted by the seller prior to closing.

      NET WORKING CAPITAL ESTIMATION AND ADJUSTMENT

      On the date the transaction is closed, neither the seller nor the buyer can necessarily precisely determine the amount of net working capital that is transferred with the business. Even if the closing date were at the end of a quarter or fiscal year, which is typically not the case, not enough time would be available to go through the regular end‐of‐period closing of the books.

      As the company uses its working capital to operate its business (e.g., during the months prior to the closing date), the composition and amount of the company's net working capital is subject to continuous change. Indeed, every sale, purchase, and payment as well as the simple passage of time can result in changes to the composition and/or amount of the company's net working capital. Moreover, the company's accounting for many transactions and various elements of net working capital are normally not in real‐time. Rather, the company's accounting naturally lags behind the underlying events, only recording certain events at the end of the day, week, month, or reporting period. While some events can be recorded in the company's books in (near) real‐time, other accounting items can generally not be finalized until the company closes its books for the relevant period.

      Transaction parties vary in their approach to selecting the preliminary amount of net working capital that is utilized to determine the purchase price to be paid at closing. On the one hand, some purchase agreements simply contain an agreed‐upon amount that was determined some time prior to closing. At the other extreme, some agreements have an elaborate pre‐closing estimation procedure that involves a proposed amount of net working capital to be used at closing, objections thereto, and even pre‐closing dispute resolution procedures. Most agreements, however, fall somewhere in between these two extremes. The transaction is often closed using a purchase price amount based on the estimated net working capital at closing, a target amount of net working capital, or an otherwise agreed‐upon amount. We discuss the determination of the target net working capital in Chapter 6.

      After the closing, the amount of net working capital that was transferred with the company can generally be determined more precisely as opposed to being estimated without the benefit of typical closing of the books procedures. Notwithstanding any dispute related to the determination of the net working capital, once the net working capital is determined post‐closing, the purchase price can be adjusted and a payment made between the parties, if any, to close out the transaction. There are three common elements to this net working capital true‐up process (barring a dispute):

      1. The target net working capital, which is part of the agreed‐upon purchase price for the transaction. In other words, if the final net working capital is the same as the target net working capital, the final purchase price equals the originally agreed upon purchase price amount.

      2. The estimated or preliminary amount of net working capital as of the closing date. The amount to be paid as of the closing date is calculated based on this preliminary amount, which can be different than the target net working capital and may result in a preliminary purchase price adjustment at closing.

      3. The post‐closing calculation of the final net working capital as of the closing date, which is determined after the fact and based upon which the final purchase price is determined.

      The adjustment of the purchase price is commonly dollar‐for‐dollar. In other words, a one‐dollar difference between the preliminary amount based upon which the transaction closed and the final net working capital amount that is determined after the fact, results in a one‐dollar purchase price adjustment (relative to the amount paid at

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