Amanda Brockwell | 16th May 2024

Locked box v completion accounts : Pricing mechanisms in M&A deals

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Amanda Brockwell | 16th May 2024

Locked box v completion accounts : Pricing mechanisms in M&A deals

In this blog, I look at 2 very common mechanisms for finalising the purchase/sale price of a company : Locked box v completion accounts.

Locked box v completion accounts

When buying or selling a company, finalising the purchase price is key : buyers and sellers focus on the headline price, (or “Enterprise Value”)- often a multiple of EBITDA of the target company, but the final price is adjusted to allow, roughly speaking, for the state of the balance sheet at the date the deal completes (“Equity Value”). 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 (ie that the sellers cannot extract value from the company between the date of the accounts and completion.)

Advantages	Disadvantages
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 (which can leave open the possibility of disputes).	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.
For the seller, the risk of deterioration passes to the buyer at the locked box date and so any fall in value of the target between that date and completion is borne by the buyer. The flip side to this is that the seller does not benefit from any profits earned by the target in the interim period up to completion although the buyer may be required to pay interest or a “ticker” on the purchase price to cover this.	It may take longer to get to completion if the locked box mechanism is adopted because more negotiations will be required earlier in the process around items such as debt and working capital to agree the locked box accounts.
The buyer can be safe in the knowledge that the purchase price will not fluctuate and this should make sourcing funding more straightforward.	There is always the possibility of “leakage” from the locked box where the seller looks to extract value in the interim period – this can reduce the value of the target at completion. If any leakage does occur the seller will have to pay compensation to the buyer. In the period between the locked box date and completion, the seller will be restricted as to how it can run and operate the business.

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 (and performance prior to) completion.

Advantages

Disadvantages

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.

Producing completion accounts can be costly and both the buyer and the seller will need to engage an accountant 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.

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.

There may be considerable delays in finalising and agreeing the completion accounts and there may be disputes as to the scope and basis on which the accounts are to be prepared.

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. As a general rule of thumb, 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 today with one of our Corporate team. To see all of the corporate and commercial services we provide, take a look at the relevant areas of our website by clicking the links.

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Locked box v completion accounts : Pricing mechanisms in M&A deals

Locked box v completion accounts : Pricing mechanisms in M&A deals

Locked box v completion accounts

Locked Box Accounts

Completion Accounts

Locked box v completion accounts : Conclusion