June 26, 2024
When buying or selling a company, finalising the purchase price is key: buyers and sellers focus on the total price, which is often referred to as the Enterprise Value. Usually the Enterprise Value is a multiple of EBITDA of the target company, but the final price is adjusted to allow, roughly speaking, for the company’s results presented in the balance sheet at closing which is often referred to as the Equity Value.
For a long time, the most common option for M&A transactions has been the use of completion accounts - and they’re still in use in large parts of the world. In recent years, however, the locked box mechanism has grown in popularity due to a strong seller’s market, an increased market demand for fast-paced M&A transactions and the desire for clean-cut exits, particularly if financial investors are involved.
So locked box v completion accounts. Which is the preferred mechanism?
A locked box deal is essentially a fixed-price deal which is based on a historical set of accounts. The buyer will assume both the risk of a fall in value and the reward of an increase in value between the date of those accounts and completion. The buyer needs to ensure that the ‘box’ is tightly locked (i.e. that the sellers cannot extract value from the company between the date of the accounts and completion.)
Locked box gives certainty on price – the buyer knows exactly what it will pay and the seller knows exactly how much it will receive at completion. The parties will agree actual values for each item in the accounts, rather than a mechanism for determining those accounts.
The buyer knows that the purchase price will not fluctuate and this should make sourcing funding more straightforward.
Thorough due diligence will be required to establish any risk of the business deteriorating between the locked box date and completion. This can be costly to the buyer and it will mean an increased reliance on warranties.
Completion Accounts
When completion accounts are used, the buyer pays an agreed purchase price on completion but this amount is later adjusted upwards or downwards based on a set of accounts produced after completion which show the position at completion to produce a final price. These accounts are used to test certain metrics, typically cash, debt and working capital or occasionally net current assets. As completion accounts are produced following completion and are based on actual metrics at the completion date, they provide a more accurate picture of a company’s value at completion.
This mechanism can help to speed up the transaction process: the parties don’t need to negotiate the exact purchase price up front. A seller’s concern at being underpaid disappears because actual and not estimated metrics of the target, at the date of completion, are being measured.
For the same reason, the buyer will be paying an accurate price and is not likely to overpay for the target. The figures used in completion accounts are based on up to date, current figures. Historical numbers, where the performance of the target may have changed in the interim, will often not reflect the target’s current situation.
Preparing completion accounts can be costly and both the buyer and the seller will need to engage accountants to assist in the negotiation of the accounts. Agreeing the rules for accounting policies to be used in those accounts and documenting them in the share purchase agreement can take time.
Which mechanism is adopted will be driven by various factors, including the buyer’s assessment (arising from due diligence) of the accuracy of the target company’s accounting records and management accounts, as well as the bargaining strength of the parties.
The potential adjustment of the purchase price when using the completion accounts bears a much higher risk of disputes for the parties post-completion. On the contrary, agreeing on a definite purchase price already at signing, as is done when using a locked box mechanism, means it is less likely for the parties to be involved in such disputes. This is particularly in the interest of the seller.
On the whole, buyers tend to prefer completion accounts and sellers prefer a locked box.
If you are thinking about buying or selling a company then get in touch with one of our lawyers in the Corporate Team.
For a long time, the most common option for M&A transactions has been the use of completion accounts - and they’re still in use in large parts of the world. In recent years, however, the locked box mechanism has grown in popularity due to a strong seller’s market, an increased market demand for fast-paced M&A transactions and the desire for clean-cut exits, particularly if financial investors are involved.
So locked box v completion accounts. Which is the preferred mechanism?
Locked Box Accounts
A locked box deal is essentially a fixed-price deal which is based on a historical set of accounts. The buyer will assume both the risk of a fall in value and the reward of an increase in value between the date of those accounts and completion. The buyer needs to ensure that the ‘box’ is tightly locked (i.e. that the sellers cannot extract value from the company between the date of the accounts and completion.)
Locked box gives certainty on price – the buyer knows exactly what it will pay and the seller knows exactly how much it will receive at completion. The parties will agree actual values for each item in the accounts, rather than a mechanism for determining those accounts.
The buyer knows that the purchase price will not fluctuate and this should make sourcing funding more straightforward.
Thorough due diligence will be required to establish any risk of the business deteriorating between the locked box date and completion. This can be costly to the buyer and it will mean an increased reliance on warranties.
Completion Accounts
When completion accounts are used, the buyer pays an agreed purchase price on completion but this amount is later adjusted upwards or downwards based on a set of accounts produced after completion which show the position at completion to produce a final price. These accounts are used to test certain metrics, typically cash, debt and working capital or occasionally net current assets. As completion accounts are produced following completion and are based on actual metrics at the completion date, they provide a more accurate picture of a company’s value at completion.
This mechanism can help to speed up the transaction process: the parties don’t need to negotiate the exact purchase price up front. A seller’s concern at being underpaid disappears because actual and not estimated metrics of the target, at the date of completion, are being measured.
For the same reason, the buyer will be paying an accurate price and is not likely to overpay for the target. The figures used in completion accounts are based on up to date, current figures. Historical numbers, where the performance of the target may have changed in the interim, will often not reflect the target’s current situation.
Preparing completion accounts can be costly and both the buyer and the seller will need to engage accountants to assist in the negotiation of the accounts. Agreeing the rules for accounting policies to be used in those accounts and documenting them in the share purchase agreement can take time.
Locked box v completion accounts : Conclusion
Which mechanism is adopted will be driven by various factors, including the buyer’s assessment (arising from due diligence) of the accuracy of the target company’s accounting records and management accounts, as well as the bargaining strength of the parties.
The potential adjustment of the purchase price when using the completion accounts bears a much higher risk of disputes for the parties post-completion. On the contrary, agreeing on a definite purchase price already at signing, as is done when using a locked box mechanism, means it is less likely for the parties to be involved in such disputes. This is particularly in the interest of the seller.
On the whole, buyers tend to prefer completion accounts and sellers prefer a locked box.
If you are thinking about buying or selling a company then get in touch with one of our lawyers in the Corporate Team.
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