Controlling tariff-related risks in purchase agreements

5 steps to consider in 2025

Recent introduction of tariffs between the United States and its international trade partners are adding complexity to deals for both buyers and sellers in M&A transactions — including how to document the accounting implications of tariffs when negotiating and drafting purchase agreements. Targeted companies that import goods affected by the tariffs into the United States, or those which rely on suppliers that import similarly affected goods, should expect to pay more for those goods, increasing both balance sheet inventory values and accounts payable, and reducing gross margin.

Both potential buyers and management may seek to evaluate supply chains and consider new suppliers to help manage those increased costs. Conversely, exporters could see reduced foreign sales (and subsequent reduced revenue) if other countries impose their own tariffs on goods from the United States. If these risks aren’t addressed before closing, companies risk post-closing disputes and lost value when preparing post-closing purchase price adjustment calculations like net working capital and earn-outs.

The following are five working capital and earn-out related considerations that should be evaluated when negotiating a deal now.

1. Negotiating to account for changing market conditions
   Parties often agree to calculate net working capital in accordance with “GAAP, consistently applied.” But how can parties to a buyout prepare financials on a consistent basis when circumstances (i.e., increased tariff costs) may shift dramatically and quickly? Parties negotiating a purchase agreement can instead agree to use an accounting hierarchy, setting forth specific provisions governing the treatment of subjective areas of accounting. For example, an accounting hierarchy can be used to measure inventory values when current inventory costs may be inflated by new tariff costs that were not levied in prior periods. Notwithstanding, a greater emphasis on tariffs could translate into specific accounting policies that govern the calculation of tariffs at closing.
   
   
2. Earn-out provisions and calculating financial metrics
   Earn-out targets are commonly based on EBITDA or other financial metrics, such as revenue or net income. Already signed purchase agreements have likely not factored in the impact of market changes due to the enactment of additional tariffs. Parties to these agreements may want to work together to consider revisions to reflect expectations of increased tariff-related costs. For companies nearing signing an agreement, metrics may need to be reconsidered to contemplate any impaired future performance and the ability of the target organization to meet post-closing thresholds. One such reconsideration could result in a move away from revenue-based earn-out targets, given pressures to increase sales prices (and therefore revenue), while maintaining volumes to cover tariff-inflated inventory costs.
   
   Parties may have agreed that post-closing EBITDA calculations add back or exclude any “one-time,” “non-recurring,” or “extraordinary” items. These terms are commonly considered a “catch-all” short-cut to identify events that parties to the purchase agreement believe could skew EBITDA when compared to the EBITDA thresholds for the earn-out, without the need to list all of those potential events. While such add-backs or exclusions may seem easy to identify (e.g., if a company has not previously been subject to tariffs and does not expect to incur increased tariff costs in the future, one might view those costs as “one time,” “non-recurring” or “extraordinary”). However, those concepts of “one-time,” “non-recurring,” or “extraordinary” are not defined under GAAP and are ripe for disagreement when preparing the closing calculations, in particular when the breadth, length and impact of tariffs is unknown.
   
   Instead, parties to the agreement should ensure it includes specific language to address how those “extraordinary” events, such as increased tariffs, should be measured (e.g., when a tariff expense should be recognized, say, when the goods are imported, or upon sale of those goods, or at a different time.).
   
   
3. Target net working capital
   Companies negotiating a purchase agreement often struggle to agree on what “normal” working capital is, which can be a highly subjective area. Agreement on this can be even more difficult when they aren’t sure what “normal business” will look like over the coming months. Typically, a company’s target net working capital figure is measured over an extended period and an average is taken to remove the effects of seasonality and monthly fluctuations. In the current environment, this may include adjusting the target net working capital amount (if recent accounting information is used) for the impact of newly implemented tariff costs. As described above, depending on the target company’s inventory accounting practices, companies may see increased inventory costs and increased liabilities compared to prior periods. For this reason, companies may wish to normalize their historic working capital data to better illustrate their ongoing positions, or exclude the impact of tariffs from the closing calculations, maintaining consistency with historic working capital data.
   
   In addition, selecting a reference period that aligns with the EBITDA period underpinning the enterprise value can ensure a working capital target amount that represents the requirements of the business at the level of earnings used for the headline price. If this headline price has been discounted to take into account expectations of lower earnings as a result of newly-enacted tariffs, the parties to the agreement may also consider adjusting the working capital target to reflect the revised level of working capital required to support these lower earnings.
   
   
4. Accounting estimates and subsequent events
   Many transactions require net working capital or earn-out calculations be calculated in accordance with GAAP, which includes evaluation of subsequent events occurring after the applicable financial statement date, to the extent they provide evidence of conditions that existed at the financial statement’s date. However, the way subsequent events are interpreted is often not sufficiently defined in a purchase agreement. Some purchase agreements are silent as to the date through which subsequent events should be considered (i.e., a knowledge cutoff date). Other purchase agreements establish a knowledge cutoff at the closing date (i.e., no subsequent events should be considered), or a knowledge cutoff upon delivery of the closing calculations (i.e., they consider only information available to the preparer up to the date they submit their closing calculations), or no knowledge cutoff (i.e., they consider all available information until the closing calculations are resolved).
   
   So how should an agreement define consideration of the effects of a major disruption, such as the implementation of tariffs on many foreign suppliers? For transactions that have recently closed, or will close while these tariffs are enacted, buyers preparing closing statements or earn-out calculations must consider how they will adjust any accounting estimates and judgments for those increased tariff costs that could change without notice. These post-closing financials may not need to be submitted for weeks or months, by which time business conditions affecting those adjustments could have shifted significantly. In a constantly evolving world, it is important that a purchase agreement clearly establishes a knowledge cutoff so that parties to it have a clear understanding of what information should be considered, and what information should not.
   
   For example, a significant drop in sales following a post-closing enactment of tariffs may call into question the valuation of inventory that is perishable or subject to expiration as of the closing date. For a business with longer-term contracts, revenue recognition may be subjective if forecasted margins decline as a result of tariffs. In more extreme cases, if the costs to fulfill a contract exceed the revenues anticipated, the contract may become onerous, triggering recognition of future losses on the balance sheet date.
   
   Given this level of uncertainty, parties to an agreement may wish to agree to specific provisions governing the treatment of accounting estimates, such as including a knowledge deadline (only considering facts known or knowable up until a certain point in time) or agreeing to specific methodologies or practices to be applied in measuring these accounting estimates.
   
   
5. Representations and warranties
   Sellers provide buyers with representations and warranties regarding the current state of a targeted business. These provide an outlook on the health of a business at the time of closing. In general, these representations and warranties do not consider specific events such as newly implemented or future tariffs. Buyers and sellers should therefore contemplate on whether specific amendments need to be made to any language within a purchase agreement in order to appropriately consider the impact of tariffs on the deal being made, considering any potential effects of events up until the date on which the purchase agreement is ultimately signed and when the deal closes.
   
   Sellers will need to consider how looming tariffs may impact the company they are selling and whether additional forward-looking disclosures may be necessary. These considerations become particularly relevant if tariff laws evolve throughout the drafting of the purchase agreement and through the closing of the deal. Conversely, buyers will need to consider the additional risks associated with the enactment of increased tariffs and ensure that representations and warranties provide adequate protection from those risks.