To lock box or not lock box
M&A transactions have traditionally used completion accounts as the preferred pricing mechanism but increasingly a “locked-box” mechanism is now being used. PWC have reported this method is reaching up to 50% for their M&A transactions over recent years. Choosing the right mechanism for the deal is fundamental to protecting and maximising value in any transaction, but which is right for your business?
The typical completion accounts process allows the buyer to measure the true value of the assets and liabilities they will inherit at completion. A locked box deal, in its simplest form, is a fixed price deal.
Completion accounts include specific rules and policies set out in the Sales & Purchase Agreement (SPA) that the parties must follow in preparing the completion balance sheet. Completion accounts SPAs will typically reference an agreed headline price and a process and mechanism by which cash, debt and working capital adjustments are made to the headline price to get to a final equity price at completion. This type of SPA will lay out specific mechanisms that determine how particular items on the balance sheet must be treated.
In its simplest form a locked box deal is a fixed price deal. The final equity price is agreed between the parties and written into the SPA. It is a known number. It protects a buyer from any value lost to the seller by the business (known as leakage) between the locked-box date and closing. The seller provides an indemnity that while there will be movements of value between assets and liabilities of the business (cash, debt or working capital) they will not extract value out of the business. All parties agree certain permitted leakage items (these include salaries, expenses paid to sellers and dividends). These amounts are specifically listed in the SPA and will be carved-out of the agreed price.
The locked-box mechanism can be quite beneficial to a seller due to the certainty of the price which is fixed at the time of signing the SPA. It also offers a quick and clean exit. The simplicity of a no closing mechanism avoids overly onerous post-sale commitments of management time or indeed legal & accounting cost.
It may not be appropriate to use a locked box if there are complex carve-outs or incomplete balance sheets, where there is a potential of business performance declining or if there is expected to be a long gap to completion, (e.g of over six to nine months).
The appropriateness of a particular mechanism will depend on the deal specifics. It is critical, whether one is a buyer or seller, to carefully consider the appropriateness of the price mechanism for the deal to minimise value and execution risk. It is important for parties to understand the key diligence needs under each mechanism. PWC have an excellent overview of the Locked box mechanisms which explains when to best use each method.
Alternatively book a confidential discussion with MD, Justin Levine who can explain specific pros and cons for your business.