How to avoid "haircuts".(Mergers, IPOs, and Venture Finance: Equities)(Professional standards)

Just before an M&A deal closes, sellers are sometimes shocked to hear that the buyer insists on a downward adjustment of the selling price--a so-called "haircut." At this point, the balance of power has shifted to the buyer, who's generally better able to walk if the seller doesn't agree to the new, lower price.

In fact, many "haircut" adjustments are quite reasonable. During due diligence, the buyer may have uncovered financial irregularities (particularly in the way revenue is recognized), undisclosed liabilities, or overvalued assets. Or else the seller may have badly missed a revenue forecast for the closing period. From the buyer's perspective, these are all grounds for re-opening negotiations about price.

Is there a way to avoid a last-minute haircut? There are three areas to watch carefully:

* The letter of intent: The best way to hold the line on an agreed-upon price is to spell out the ground rules for closing adjustments in the letter of intent. The seller should make sure the agreement is specific about what happens in the event that due diligence uncovers some unpleasant surprises.

* The closing period: The final weeks between the LOI and the closing can be intensely distracting, and it's easy to let the sales effort slip and to approve expenditures that might otherwise get turned down. Yet this is arguably one of the most critical periods in the seller's financial history and should be managed with extra care.

* Final cash: In a deal that's structured fairly, price is adjusted downwards or upwards based on cash or current assets on hand. If the balance is above the negotiated number, the difference adds to the selling price; if less, it subtracts. Thus, a last-ditch effort to collect receivables or book new sales may actually produce a haircut adjustment in the seller's favor.

Ward Carter, executive vice president, Corum Group, 10500 NE Eighth St., Bellevue, Wash. 98004; 425/455-8281. E-mail: wardc@corumgroup.com.

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