Purchase Price in M&A: Locked Box vs Completion Accounts

DATE PUBLISHED: June 23, 2023

key takeaways

While every transaction is fundamentally different, purchase price in a share purchase transaction is commonly structured through either a Completion Accounts or Locked Box mechanism.
Understanding the difference between these two pricing mechanisms is vitally important to ensure the purchase price is calculated, structured and paid in the most appropriate manner possible.
Sellers and buyers of shares should carefully consider the advantages and disadvantages of each purchase price mechanism and determine which is more suitable in the circumstances.

Completion Accounts v Locked Box

In share purchase transactions, there are a number of different ways that parties can determine the final acquisition price that is paid by a buyer.

Ultimately, how the purchase price is calculated and how it is paid will change on every deal. However, there are two widely accepted mechanisms for adjusting the consideration for a share transaction:

1
Completion Accounts; and
2
Locked Box.

In this article, we explore how these pricing mechanisms work, when one is more appropriate than the other, and what the key advantages and disadvantages of each structure (from both a buyer and seller perspective).

Completion Accounts

The Completion Accounts mechanism is often regarded as the “buyer-friendly” option as it grants an opportunity for the buyer to prepare the completion balance sheet (and provides them with greater certainty on the actual financial position of the target group as at completion of the deal).

In a Completion Accounts scenario:

1
the "top-line" purchase price will be defined in the Share Purchase Agreement (SPA); but
2
the "final" purchase price that is ultimately paid by the buyer will be determined once an actual balance sheet for the target group (as at the completion date) is prepared and agreed between the parties.

If the completion balance sheet provides that the target group does not have sufficient working capital (usually based on the target’s historical average) or has higher than agreed debt, then the purchase price will be adjusted in favour of the buyer.

On the other hand, if the target group has excess working capital at completion or lower than agreed debt, then the purchase price will be adjusted in favour of the seller by the amount equal to that additional working capital.

Subject to the terms of the SPA, either party may prepare the draft Completion Accounts (and the other party will typically have the right to review and either approve or dispute those draft accounts). However, it is more common for the buyer to prepare the Completion Accounts, as it is the owner of the target group at that time.

Set out in the table below are the advantages and disadvantages of a Completion Accounts mechanism in a SPA:

	Advantages	Disadvantages
Buyer	1. (Purchase price certainty) Completion Accounts provide a buyer with more certainty that they will pay based on the actual value of the target group. 2. (Control over process) the buyer will typically "hold the pen" on the preparation of the Completion Accounts, and can use this as a purchase price risk mitigation tool.	1. (Costs) unless the SPA provides otherwise, the buyer will bear the costs of preparing the Completion Accounts. 2. (Accounting policies) there may be disagreement with the seller on the proper accounting principles for certain line items forming part of the Completion Accounts.
Seller	1. (Due diligence) given the buyer will have greater certainty on purchase price, this tends to reduce the time and effort during the buyer's financial due diligence. 2. (Benefit of excess profits) if that target group has excess cash and working capital, the seller will receive the benefit of that once the Completion Accounts are prepared and agreed.	1. (Purchase price uncertainty) the seller will I have less certainty on purchase price, and depending on the outcome of the Completion Accounts, may be required to hand purchase price back to the buyer. 2. (Accounting abnormalities) there can often be disputes with the buyer over the calculation of certain balance sheet lines (and the appropriate accounting principles that apply to those line items). 3. (Purchase price hold back) usually part of the seller's purchase price will be held back as security for any adjustment under the Completion Accounts in favour of the buyer.

Locked Box

A Locked Box transaction typically involves the parties agreeing on a fixed purchase price based on the target group’s financial statements at an agreed point in time in the past (being the locked box date) with conventionally no post-completion adjustment.

The most common choice of locked box date is the target group's last financial year end (as this allows audited accounts to be used).

By avoiding a post-completion price adjustment, the seller shifts the risk of current trading of the target group onto the buyer. This makes Locked Box accounts attractive to a seller as it provides them more certainty on price pre-completion.

The obvious concern for a buyer is that a fixed purchase price can leave a buyer open to sell-side manipulation of the target or target group's financial position. To deal with this, the SPA will usually include:

1
more rigorous and onerous pre-completion obligations on the part of the seller and the target or the target group (if they are made a party to the SPA); and
2
specific undertakings on the part of the seller not to extract certain value (in the form of cash, assets or other benefits, together defined as leakage) from the target group in the period from the locked box date until completion.

The seller will also usually be required to indemnify the buyer for any leakage claims that are made by the buyer after completion (allowing the buyer to recover this from the seller on a dollar for dollar basis).

Set out in the table below are the advantages and disadvantages of a Locked Box mechanism in a SPA:

	Advantages	Disadvantages
Buyer	1. (Trading benefit) if the target group is profitable in the period between the locked box date and completion, the buyer will obtain the benefit of that trading period. 2. (No Completion Accounts) the buyer will not be required to prepare Completion Accounts for the transaction (saving time, costs and a potential dispute with the seller).	1. (Trading detriment) the buyer bears all the risk of any and all unprofitable trading that occurs after the locked box date. 2. (Due diligence) the buyer will need to undertake more comprehensive financial due diligence on the target group. 3. (limited purchase price protection) other than warranty protections and an indemnity for any leakage, the buyer has no post-completion protection against falls in purchase price.
Seller	1. (Purchase price certainty) because the purchase price is "locked" in the SPA (save for any leakage), the seller has certainty over what they will receive for their shares in the target group. 2. (No disputes) there will be no negotiation or dispute over items in the Completion Accounts, and the seller can walk away into the sunset with their purchase price. 3. (Early to review bids) if the transaction is subject to a competitive bidding process, it is easier for the seller to determine which deal is the most attractive (and offers can be compared on a like for like basis).	1. (Warranties and indemnities) the buyer will typically expect the seller to provide more substantial warranties under the SPA (and such warranties and indemnities would have fewer limitations). 2. (Audited accounts) a buyer will typically only agree to a locked box arrangement where the accounts of the target group are audited (which is a costly exercise for a seller and target group who are not ordinarily required to their accounts audited)

conclusion

As we start to see a shift away from the seller friendly market that has operated for the past 24 months, in our view, Completion Accounts are likely to be more prevalent on share purchase transaction in the foreseeable future. Nonetheless, weighing the specifics of each deal is an important step that will help decrease your risk and improve your likelihood of success.

What completion mechanism is more appropriate is ultimately dependent upon the size of the transaction, the level of due diligence afforded to the buyer, what is being acquired/sold and the complexities around the purchase price.

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