Enterprise Value & Equity Value in german practice

Purchase price determination for the acquisition of a company in Germany

For buyers and sellers, enterprise valuation and purchase price determination are central to the process of acquiring a company in Germany.

In many cases, the course is set very early in the transaction process, namely when the LoI (Letter of Intent) is concluded, for the determination of the enterprise value and then also for the reconciliation of this enterprise value to the equity value, i.e. the purchase price.

Particularly in the case of a sale to financial investors, the mechanisms of cash free and debt free, target net working capital and the agreement of locked-box accounts versus closing accounts play an essential role in german practice. In order to avoid misunderstandings between the seller and the buyer, clarity about the structure of the transaction should therefore be achieved at an early stage.

General information on the german company acquisition process can be found here.

Legal expertise in M&A transactions in Germany

Our experienced interdisciplinary teams of specialized tax advisors and german corporate lawyers assist transactions end-to-end, from LoI to closing, and take an approach at all stages of the process to achieve the best deal structure and the optimal economic and financial outcome for our clients.

Our range of nationwide advice includes in particular:

1. Setting up and structuring the process
2. Determination of the optimal deal structure - asset deal vs. share deal
3. Support with regard to tax issues and company valuation
4. Preparation and execution of the due diligence for the acquisition of a company
5. Preparation and negotiation of the complete transaction documentation, in particular SPA (Share Purchase Agreement) and accompanying documentation
6. Preparation of other necessary corporate law documents as well as managing director and executive board contracts

Enterprise value: starting point for determining the purchase price in german practice

Usually, investors or buyers present the enterprise value of the target they are addressing (target company to be sold) as part of the LoI. The enterprise value in Germany is usually determined using a DCF (discounted cash flow) method, in which future cash flows are discounted on the basis of a business plan.

The enterprise value determined in this way is then often tested using a simplified multiple method, in which the enterprise value is set in relation to EBITDA, i.e. earnings before interest, taxes, depreciation and amortization of the last full financial year and/or the expected profit of the current financial year. In structured german sales processes, interested parties are usually requested in the process letter to fully disclose the valuation system and assumptions they have used, which only very few bidders actually do.

Purchase price calculation using cash free and debt free + target net working capital in german practice

In german practice, the enterprise value calculated according to the system described above represents a gross enterprise value to a certain extent, as neither liquid funds - cash - nor the debt ratio - debt - have been taken into account. In this respect, the net cash or net financial position is first determined on a reporting date to be agreed. For this purpose, all interest-bearing liabilities, in particular loans, are deducted from the reported cash and cash equivalents. The balance sheet items to be taken into account in this process harbor a potential for conflict that should not be underestimated; an example of this is the valuation of pension obligations. In Germany, the buyer then usually protects himself against an optimization of the net cash by having the seller guarantee a so-called target net working capital. This target net working capital is determined as an average value during financial due diligence, whereby sellers have an interest in the lowest possible value, while the buyer's interest goes in exactly the opposite direction. The background to this guarantee is that the buyer wants to prevent the seller from optimizing the net cash position by changing payment terms.

In german law, the decisive factor with regard to the correct classification of the cash free and debt free concept is that this is a purchase price adjustment mechanism. Initially, nothing happens at the level of the target.

A simple example will illustrate this mechanism: The EV is 10m EUR. The net cash position is 1m EUR. In this example, the purchase price (equity value) is therefore 11m EUR, provided that no further adjustment is made due to an over- or underrun of the net working capital position.

General information on purchase price clauses and purchase price adjustments Earn out, Fixed price and Cash free, Debt free in german law can be found here.

Purchase price adjustment in Germany: locked box accounts vs. closing accounts

In connection with the determination of the purchase price (equity value), the question arises as to which reference date should be used. Two concepts have become established in german practice. One is the so-called locked-box accounts concept, in which a reference date in the past is used to determine the purchase price adjustments. This concept always makes sense if there is not too long a period of time between the reporting date of the relevant annual financial statements and the signing or closing of the transaction. With the locked-box accounts concept, the purchase price is determined on the basis of "outdated figures". The risk of the ongoing liquidity development therefore lies with the buyer, but he is also entitled to the liquidity generated. Often in german practice, an interest rate is negotiated on the purchase price in order to compensate the seller for the free liquidity generated since the balance sheet date.

Secondly, there is the so-called closing accounts concept. Here, interim financial statements are prepared as of the closing date, which then form the basis for determining any purchase price adjustments. Questions that often need to be clarified in german practice in this context are which party bears the costs of preparing the interim financial statements and any audit, or whether and, if so, which different accounting approaches are chosen. Both concepts have their justification, but it is advisable to obtain clarity on the choice of the specific concept at an early stage in Germany.

Distribution of liquidity as an alternative to purchase price adjustment in Germany

As an alternative to a purchase price adjustment as described above, the buyer and seller in Germany can also agree that surplus liquidity is distributed to the sellers as part of the transaction or in advance. It should be noted here that in the case of particularly liquid companies, there are often insufficient profits to pay out all liquidity. Also, for german legal reasons, advance distributions during the year cannot be made at all (in the case of the AG) or only within narrow limits (in the case of the GmbH). Distributions can therefore rarely ensure that all surplus liquidity is actually transferred, and in this context there is always the question of the necessary financing of the company after the transaction has been completed.

Conclusion: Managing processes correctly in Germany

Experience shows that clarity and a clear understanding of the deal mechanisms should be established at an early stage, i.e. during the negotiation of the LoI in Germany. This prevents positions that the parties assumed were agreed from having to be reopened in the course of the process and, in the worst case, even jeopardizing the entire transaction.