What Does Purchase Price Concession Mean?
A purchase price concession is an adjustment to the purchase price agreed to in the letter of intent. It occurs during or after due diligence, but before closing of the transaction. Typically, these adjustments are reductions of the purchase price, but they may also be increases.
They occur when a) a particular assumption used in the initial valuation is proven to be incorrect, b) an existing circumstance is uncovered during due diligence that will impact the company's estimated future earnings (i.e. the existence of ligation), or c) either non-cash working capital, capital assets, or real estate have been pegged at a specific value and appraisals come in below these specified values.
Divestopedia Explains Purchase Price Concession
Purchase price concessions can usually be negotiated between the buyer and the seller, particularly if the buyer is motivated to complete the transaction. Some buyers complete due diligence specifically to identify purchase price concessions. Other buyers are more interested in finding opportunities for synergies and value creation post-transaction, rather than looking for ways to reduce the purchase price.
Non-cash working capital discrepancies are particularly common. Usually, buyers will estimate how much non-cash working capital is required to sustain the estimated annual revenue. They will then peg this number, and adjust the purchase price up or down dollar-for-dollar as a purchase price concession if the non-cash working capital delivered is above or below the peg. Similarly, capital asset appraisals are another common source of purchase price concessions. The seller will typically estimate the fair market value of the tangible assets during the initial negotiation and valuation. Then, the buyer will reserve the right to adjust the purchase price on a dollar-for-dollar basis if the appraisal value is lower than the original estimate.