Purchase Price Mechanisms: Locked Box vs Completion Accounts Mechanism

When it comes to mergers and acquisitions, the process of structuring a deal can be complex. It requires careful consideration of the various mechanisms to assess how the purchase price should be calculated.

The two most popular mechanisms to determine the purchase price are the “Locked Box” mechanism and the “Completion Accounts” mechanism.

“Locked Box” mechanism

The “locked box” mechanism is a method used to determine a company’s value on a specific date, commonly referred to as the “locked box date.”

In this instance, the buyer pays the purchase price at completion, based on the value of the company as set out in the company’s financial statements as at the “locked box date”.

Any funds received or expended after the “locked box date” until the completion date (known as the “locked box period”), typically remain with the seller. The exception to this is any extraction of value from the company, which is not permitted by the buyer, (commonly known as “leakage”) within the “locked box period”.

It is important that the Share Purchase Agreement (SPA) covers exactly what amounts to “leakage”, in order to eradicate any room for dispute further down the line. No adjustment is made to the purchase price post completion (unless any “leakage” has occurred and the seller is required to compensate the buyer).

Advantages of the “Locked Box” mechanism

1. Certainty: Provides a sense of certainty for both the buyer and the seller by establishing a fixed purchase price based on a specific date.
2. Efficiency: Streamlines the process by minimising the requirement for post-completion adjustments and negotiations. This can save management time post-completion and enables the buyer to focus on moving the business forward.
3. Costs: parties do not have to incur the costs of preparing/ reviewing completion accounts.

Disadvantages of the “Locked Box” mechanism

1. Not always suitable: The locked box mechanism is not always appropriate for particular industry sectors/companies.
2. Difference in Value: Depending on the performance of the company in the “locked box period”, there may be a difference in the value between the purchase price paid and the value of the company at completion, which may not be preferable to a particular buyer/seller.

“Completion Accounts” mechanism

The “completion accounts” mechanism involves calculating the purchase price by considering the company’s financial position at the completion date.

Ordinarily, the buyer pays an initial amount at completion, based on an estimate agreed between the parties.

Once the deal has been completed, a set of completion accounts is prepared (which are then agreed upon or determined) to make adjustments to the purchase price, taking into account any changes that have occurred in the company’s financial position (such as assets, liabilities, or working capital) up until completion.

Again, it is important that the SPA covers exactly what is to be “captured” in the “completion accounts” to ensure certainty.

Once the completion accounts have been agreed/determined, the final purchase price is calculated and any adjustments will be paid to the buyer/seller (as applicable).

Advantages of the “Completion Accounts” mechanism

1. Accurate Valuation: Provides a more accurate valuation, by accounting for changes in the company’s financial position up to the completion date. Put simply, the buyer “gets what it pays for” and a seller gets the benefit of any profit generated up until completion.
2. Risk Mitigation: Helps mitigate risks associated with inaccuracies or undisclosed items in the seller’s financial statements.
3. Adjustment Flexibility: Allows for adjustments in the purchase price to reflect changes in the company’s value until completion.

Disadvantages of the “Completion Accounts” mechanism

1. Less certainty: The final purchase price may not be known until a period of time following completion, which may not be favourable.
2. Timings: sellers have to wait longer to receive an element of the purchase price.
3. Costs: both parties have to incur the costs of the preparation/ review of the completion accounts.
4. More potential for dispute: Arguably more room for disputes between the parties over the final purchase payable.

Which purchase price mechanism should I choose?

When considering how the purchase price of a deal should be calculated, it is important to thoroughly assess various factors.

It requires active discussions with your accountant, effective negotiations, and a deep understanding of the dynamics of the deal (including the level of trust between the buyer and the seller, deal timelines, and negotiation power).

It is also necessary to consider the nature of the business in question, the prevailing market trends and norms within specific industries, and ultimately the preferences of the parties involved.

How can we help?

Wilson Browne Solicitors’ Corporate and Commercial team of experts is well-positioned to provide advice on all elements of purchasing or selling a business.

For a confidential and no obligation initial discussion about how we may be able to help, please contact the Corporate and Commercial team at 0800 088 6004.