The fundamental bargain of M&A seems pretty simple. At the closing of a deal, the buyer pays the seller, and gets a business in return.
It hasn’t been so straightforward for the family who agreed in 2022 to sell its California supermarket Save Mart to the private equity firm Kingswood Capital Management, which valued the grocery chain at $245mn.
Three months after the papers were signed, Kingswood demanded that Save Mart’s prior owners, the Piccinini family, fork back over $109mn after already surrendering the company. In effect, Kingswood wanted to receive a net $77mn payment to take over Save Mart.
And thanks to some ballsy lawyering and nebulous bookkeeping, it seems the PE firm might actually succeed, its gambit upheld by a controversial arbitration ruling in September 2023.
This outcome “fully invert[s]” the original deal, the Piccininis say in court filings. The family is appealing to the Delaware Supreme Court.
The saga is a window into the vagaries of private-company dealmaking, and how esoteric financial accounting can be weaponised by a canny counterparty.
When Kingswood signed the deal for Save Mart, it was really acquiring two separate businesses. One was the Save Mart grocery chain, comprised of 200 stores and more than $4bn in annual revenue. Save Mart separately held a majority stake in Superstore Industries (SSI), a successful food wholesaler/distributor that had two other owners.
Kingswood initially valued the package at $270mn in a 2021 letter of intent. But by the time of deal agreement months later, both sides had agreed on a $245mn valuation.
This would be a so-called “debt-free, cash-free” acquisition. That means the Piccininis would hang on to the roughly $200mn of cash that had been on Save Mart’s balance sheet, and deliver the business clean of any associated debt.
So the actual net payment to the Piccininis, after wiping Save Mart’s existing debt and certain liabilities, would be about $32mn:
This is not to say that Save Mart would actually end up debt-free, of course, as Kingswood tapped its own sources of financing to fund its purchase:
The two sides agreed that Save Mart’s equity stake in SSI, the joint venture, would be valued at $90mn, a significant step up from the ~$22.5mn value that Save Mart had assigned the investment on its books.
The increase reflected SSI’s valuable land portfolio, according to one person familiar with the transaction. And it enables Kingswood to lower SSI’s tax basis should it ever want to sell SSI, according to a person involved in the transaction.
Those seem reasonable enough. Still, the accounting of SSI’s value is what laid the foundation for this dispute.
For context, a company’s investments can be recorded on its balance sheet in three ways: cost method, equity method, and full consolidation.
Save Mart selected the equity method for its SSI stake.
To explain a bit further: Let’s imagine a company with $100 of asset value and $60 in liabilities, which leaves it with an equity value of $40. Say this company has a 50-per-cent owner, meaning it owns $20 in equity. The owner’s balance sheet would list that $20 as a single line item, called “equity in unconsolidated affiliates”. That account would grow with the subsidiary’s proportional net income, and decrease with any net losses or dividends.
Save Mart’s stake in SSI was listed as a single line on its balance sheet — worth $22.5mn — as seen below. (Sometimes the equity method is referred to as a “one-line consolidation”).
If you’re still following along (and how could you not!) this is where the fight begins.
In March 2022, Kingswood and Save Mart closed their deal with the PE firm sending payments based on the family’s proposed accounting. That then set off a final round of post-closing negotiations, where Kingswood got 90 days to argue with the Piccinini’s maths.
Now, this final round only really exists to prevent outgoing executives from degrading the business — to, say, pay a big dividend to the company’s prior owners. So at this stage of a deal, any adjustments are usually very minor.
But Kingswood dropped in one massive adjustment with the boilerplate.
It added back $109mn of gross SSI debt, and asserted that the figure counted as official “Indebtedness”. And it argued it should be paid back for all that additional debt.
The PE firm pointed to the language in the deal contract, and said the definition of “Indebtedness” included any Save Mart “group” debt. In other words, 100 per cent of SSI’s debt was fair game to include in the purchase-price adjustment, even though it was already embedded on Save Mart’s balance sheet, through its equity-method calculation of its ownership stake.
Here is the $109mn adjustment that Kingswood casually sent back to the family:
Understandably, the Piccininis did not accept this, and the conflict went into arbitration where they offered a series of arguments against Kingswood.
First, the family said the $90mn value ascribed to the SSI stake was a net equity figure that already incorporated Save Mart’s pro-rata portion of the aggregate $109mn SSI debt. As such, bringing back that gross $109mn amount would then inappropriately force the “double-counting” of the debt.
They further argued that if the SSI debt was to be added back, then what it called the “fruits” of the debt — the inventory and accounts receivable on the other side of the ledger that the debt funded — should be netted against the $109mn.
Second, the family argued that the SSI debt had already been classified in the “Undisclosed Liabilities” section of the representations and warranties disclosures, and thus all sides had explicitly agreed that the $109mn was to be excluded from the Indebtedness calculation.
And third, the Piccinnis said, Kingswood’s interpretation of the agreement simply doesn’t make any sense. Why would they agree to a deal to write a private equity firm a check for ($32mn - $109mn) = - $77mn?
This type of hardball is bizarre in buyouts because buyers and sellers usually nail down definitions before any money changes hands.
The contract had been heavily negotiated for months, with corporate lawyers, investment bankers, consultants and accountants on the scene. Kingswood, the family argued, had never flagged SSI’s debt treatment before the June post-closing submission.
Arbitrator Joseph Slights III, a lawyer in private practice who was formerly a Delaware Vice Chancellor, did not ultimately buy any of what the Piccinnis were selling.
He wrote in the arbitration decision: “Delaware law is more contractarian than most, and Delaware courts will enforce the letter of the parties’ contract without regard for whether they have struck a good deal or bad deal . . . the result is not absurd or commercially unreasonable.”
He added that the family could have negotiated a tighter agreement and that it was not clear to him that the $90mn equity value of SSI was truly net of proportional debt and that there was $206mn of Save Mart balance sheet cash that was swept up which the family could use to pay the $109mn.
Kingswood and its lawyers at Kirkland & Ellis quickly moved to have the Delaware Court of Chancery confirm the arbitration ruling. The chancery court in February did so confirm, albeit reluctantly.
Vice Chancellor Travis Laster said in his decision he would have ruled differently than Slights. Still, he declined to overturn the ruling because he couldn’t find “manifest disregard for the law” in the decision.
The Piccinnis, understandably, believe writing a cheque for $109mn is indeed “absurd” and “commercially unreasonable”. They have accused Kingswood of “bad faith” and “gamesmanship” in their court papers.
They will now appeal to the Delaware Supreme Court, pointing to a 2017 decision that said in a post-closing adjustment dispute, the legal system should aim to uphold the broader spirit of the contract instead of narrow contract definitions.
Depositions of Kingswood executives helps answer one of the key mysteries of the case: why did the private equity firm broach the SSI debt question after closing, and not before?
From Michael Nieg sch* , the self-described Kingswood “deal quarterback” for Save Mart:
We were surprised that the seller didn’t put any SSI debt in their definition of indebtedness as of the closing, and our view was, if that’s what they believed and we raised it, we thought it would be a contentious topic . . .
Again, we had had a draft purchase agreement from them dating back to, you know, December that clearly laid out the debt of operating subsidiaries, as well as debt guaranteed by Save Mart was, in fact, indebtedness for purposes of the transaction. Again, it’s a very standard definition. So no, we assumed that they had read their own document that they drafted . . .
Because our perspective was, per the purchase agreement, SSI debt was to be included in indebtedness. For some reason, which we don’t know why, that appeared not to be the perspective of the seller at the time that they delivered the preclosing statement . . .
We were not going to speculate why we had a different perspective on SSI debt. Our view was it could be a contentious topic and we’d rather deal with it after we had closed , which is something we were required to do.
From Kingswood’s Clay Lechleiter*:
[G]iven that Kingswood thought that indebtedness included the SSI debt, because it was borrowed money and because of the guarantee, we were surprised that they had not included it.
Given the contentiousness of the negotiations and the transaction with the seller, we made a strategic decision to address the SSI debt post close via the mechanic in the EPA that allows for that .
In other words, Kingswood had believed, all along prior to signing and closing, that the gross SSI debt belonged on Save Mart’s main balance sheet. But they decided to keep quiet about that until after the deal closed.
One implication is that they were happy to close on the Piccininis’ terms, and winning on the SSI debt issue would be a bonus, given that there was no guarantee of winning the arbitration.
The firm’s equity check on the $240mn transaction was just $60mn (see the sources and uses table above). If Kingswood is eventually paid the $109mn, it will receive nearly two times their equity contribution by weaponising accounting and legal technicalities.
It seems like a masterstroke.
Kingswood’s founder, Alexander Wolf, cut his teeth at Cerberus Capital Management (named for the three-headed dog guarding the gates of hell) and Ares Management (Greek god of war), two firms not afraid to play rough.
A person familiar with Kingswood’s thinking told the FT that the firm was merely enforcing the contract as written, as any other party would do. Moreover, the Piccininis did well for themselves between the $200mn in cash swept and a previous sale-leaseback transaction, this person said.
Still, Kingswood will want to do more deals down the road. And their counterparties from now on will need to be extra careful in doing their homework.
Further reading: — Arbitration ruling, September 2023 — Delaware Court of Chancery confirmation of arbitration, February 2024 — “Raw Deal: Seller Ordered to Pay Buyer Over Twice the Purchase Price in Post-Closing Purchase Price Adjustment Dispute”-- Cleary, Gottlieb memo
* We misspelled Michael Niegsch’s and Clay Lechleiter’s names in earlier versions of this post. Sorry!