November 16, 2022
In a seller-friendly market, there is often a move towards a fixed price or locked box mechanism on a company sale. The locked box pricing mechanism works on the premise that the price payable for the target company or business is calculated before the acquisition agreement is signed, based on a set of pre-completion accounts drawn up to an agreed date. The agreed date is typically referred to as the ‘locked box date.’
There is no prescriptive form that locked box accounts need to follow but they are typically end of year accounts, recently available management accounts or a pro forma balance sheet specifically prepared for the transaction. Once the price has been determined by reference to the locked box accounts, the purchase price is fixed. It is worth noting that this has two key implications:
A locked box mechanism is typically less time consuming to draft because provisions relating to completion accounts are not required but there are two key areas that must be addressed in any acquisition agreement:
When the buyer and the seller agree to adopt a completion accounts structure, the final purchase price is calculated after the transaction completes by reference to completion accounts. This allows the buyer to test, and ultimately adjust, its valuation by reference to the actual balance sheet that is prepared as at the date of completion. This differs from a locked box mechanism whereby the purchase price is fixed before the acquisition agreement is signed and completion of the transaction.
Completion accounts are commonly used for:
What do completion accounts measure?
The type of deal transaction will dictate what assets and liabilities are to be measured in the completion accounts and a range of factors can influence the buyer’s decision regarding financial metrics, such as:
Commonly adopted price adjustments
The most commonly adopted price adjustments based on completion accounts include:
Structuring of completion accounts
Completion accounts serve a practical function rather than a statutory one and, as a result, the format, content and basis for preparation of these are driven solely by the demands of the transaction. The mechanics governing the preparation of the completion accounts are set out in the acquisition agreement. As to who prepares the completion accounts, this is a discussion point for the buyer and the seller as commercially it may be more appropriate for one party to draft them over the other. As there is no set form of completion accounts, it is essential that the acquisition agreement contains the basis on which the accounts are to be prepared. The period to which the completion accounts relate will be a negotiation point for the buyer and the seller, but they typically cover the period from the date to which the target’s last accounts were prepared, to the date of completion. It may be appropriate to also set a time of day to which the completion accounts are prepared, but that will depend on the nature of the business.
Whilst the final purchase price will not be known until the completion accounts have been agreed or determined, the buyer will typically pay a substantial provisional sum to the seller on completion as a payment on account of the purchase price. Once the completion accounts have been agreed or determined, there is then a further payment to (or a repayment by) the seller to the extent that the provisional price exceeds or falls short of the finally determined purchase price.
It is in both parties’ interests to ensure that the provisional amount paid by the buyer to the seller on completion is as close to the final purchase price as possible. From the buyer’s perspective, it does not want to have to rely on the clawback mechanisms within the acquisition agreement. In addition to the wasted costs and negative impact on cash flow caused by funding the initial overpayment, the buyer will also be exposed to the risk that the seller may be unable (or unwilling) to comply with its obligations under the clawback provisions.
From the seller’s perspective, apart from the obvious cash flow drawback, an underpayment at completion also carries a similar credit risk concerning the buyer’s ability to make the necessary top-up payment under the price adjustment mechanism.
Arran Brooker is a senior associate in Teacher Stern’s corporate department. You can contact Arran at firstname.lastname@example.org.
David and Arran act for public and private corporates, institutions, individual entrepreneurs and management teams on a broad range of corporate transactions, including mergers & acquisitions, private equity and venture capital investments, joint ventures and shareholder structures in a variety of sectors including hospitality, sport and real estate.
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