To lock the box or not, that is the question! Our Corporate Finance Partner Clive Smetham provides a high-level insight into the differences between a locked box mechanism and traditional completion accounts.
The final consideration payable for a company sale is commonly determined by a closing balance sheet adjustment mechanism. Detailed accounts, called ‘completion accounts’ are prepared after completion and used to determine the actual value of the business. Completion accounts can be a long, expensive and sometimes confrontational exercise.
A locked box mechanism is an alternative, simpler approach. Under a locked box mechanism, the purchase price is based on historic accounts signed off on a date prior to completion, called the ‘locked box date’. Since the price is fixed, the vendor is certain there will be no price reduction, and the purchaser knows the amount of cash required.
The purchaser cannot adjust the consideration after completion and must rely on the warranties and indemnities in the contract. Typically, the purchaser requests the ‘locked box accounts’ be reviewed (or audited) by an independent accountant.
This alternative approach is particularly relevant for vendors seeking a quick sale, or for sought-after companies, which will generate competitive tension through an auction process.
The benefits of a locked box mechanism are:
- The purchase consideration is fixed, providing certainty to both parties;
- Complex clauses in the contract covering completion accounts, including detailed accounting policies and mechanisms for adjusting the price, are not required thus saving professional fees and preserving the relationship between the purchaser and vendor; and
- Completion accounts are not needed, thus saving time and fees, avoiding protracted arguments over accounting details, and enabling the purchaser to concentrate on running and integrating their new acquisition.
Outflows of cash between the locked box date and completion (called “leakage”), other than ordinary course of business transactions, need to be prevented so the parties ordinarily agree a list of items of ‘permitted leakage’.
The timing of when the purchaser benefits from the transaction is a key consideration. Under the locked box approach, the economic interest effectively passes from the locked box date, so the purchaser benefits from profits generated from that date. Conversely, the vendor loses the reward for those profits (an opportunity cost) – although mitigation strategies can compensate for this.
The advantages and disadvantages of the locked box approach are:
|Provides certainty for purchaser and vendor||Purchaser needs extensive financial due diligence|
|Saves time and professional fees (it’s simple)||Inappropriate when performance is unpredictable, or the business cannot be valued with certainty before completion|
|Easier to compare competing offers||Vendor suffers an opportunity cost, especially if profits rise between the locked box date and completion|
|Enables new owners to concentrate on running their latest acquisition|
In conclusion, whilst the locked box mechanism is a useful alternative to preparing completion accounts, it is not suitable for every transaction and can give rise to its own problems if used inappropriately. In the right circumstances, it can save both parties time and costs and provide clarity on the sale consideration. It is therefore important that you engage experienced advisors.
If you have any questions, please give us a call on 0113 231 4131 or email firstname.lastname@example.org.