Locked Box v Completion Accounts in UK acquisitions

Locked box mechanism: summary
The locked box mechanism is a method where the purchase price is fixed based on the target company’s balance sheet at a specific date before completion of the transaction, known as the “locked box date”. The key features are:

• Fixed price: the purchase price is agreed upfront, using the company’s most recent financial statements (often audited, but not always).
• No post-completion adjustments: there are no adjustments to the purchase price after the completion date.
• Leakage provisions: to protect the buyer, the seller must indemnify the buyer for any value extracted from the company (known as “leakage”) between the locked box date and the completion date.
• Value accrual: sellers may negotiate compensation for maintaining the business during the locked box period, often in the form of interest on the purchase price.

Locked box mechanism: advantages/disadvantages
The key advantages are: certainty, as both parties have a clear understanding of the purchase price at the outset, and simplicity, as the absence of post-completion adjustments simplifies the transaction process.

The main disadvantages are: the risk of value leakage, as buyers must ensure robust due diligence to prevent any value extraction that could diminish the target company’s worth before completion, and less flexibility, as the mechanism may not be suitable for companies with volatile working capital or performance. The locked box mechanism is, therefore, generally seen as a more seller-friendly approach.

Locked box mechanism: areas of dispute
Disputes can occur over:

• what constitutes leakage (unauthorised value extraction), and whether any such leakage has occurred between the locked box date and completion;
• what is considered permitted leakage, which are specific exceptions agreed upon in the acquisition agreement;
• the amount and calculation of such interest on the purchase price as compensation for the sellers for maintaining the business during the locked box period; and
• the accuracy and reliability of the financial statements used to determine the locked box price.

Lawyers will work closely with financial advisors to ensure that the drafting of the acquisition agreement around these areas is as detailed as possible to avoid a potential dispute.

Completion accounts: summary
Completion accounts involve determining the final purchase price based on the target company’s financial position at the completion date. The key features are:

• Estimated purchase price: an initial price is agreed, subject to adjustment based on the actual financial position at completion.
• Post-completion adjustments: after the transaction, usually it is the buyer that prepares completion accounts to reflect the company’s actual financial status at the completion date. These are then reviewed and hopefully agreed by the seller.
• Adjustment Mechanism: any difference between the estimated and final purchase price is settled through a purchase price adjustment.

Completion accounts: advantages/disadvantages
The advantages of completion accounts include accuracy, as the final purchase price reflects the target company’s actual financial position at completion, and flexibility because the mechanism is suitable for companies with fluctuating working capital or performance.

The disadvantages include complexity, as the process of preparing and agreeing completion accounts can be time-consuming and resource-intensive, and uncertainty, because the final purchase price is not known until after completion, which can create uncertainty for both parties.

Completion accounts: common disputes
Disputes may arise over:

• the accuracy of the completion accounts, particularly regarding the valuation of assets, liabilities, and working capital adjustments;
• differences in interpreting accounting policies and principles can lead to disagreements on how certain items should be treated in the completion accounts;
• the process of adjusting the purchase price based on the completion accounts, especially if there are significant differences between the estimated and actual financial positions; and
• delays in preparing and agreeing the completion accounts, potentially delaying the final settlement.

As mentioned in the locked box mechanism section, it is important for lawyers and financial advisors to work closely together to ensure that drafting around these areas in the acquisition agreement is as detailed as possible to avoid a potential dispute.

Comment
The appropriateness of using a locked box mechanism vs completion accounts to determine the final purchase price depends on various factors, including the nature of the target company, the transaction’s complexity, and the parties’ risk tolerance.

Generally speaking, a locked box deal is for straightforward transactions where price certainty and simplicity are paramount. In contrast, completion accounts are better suited for transactions involving companies with variable financial performance, where accuracy in the final purchase price is key.

In conclusion, both mechanisms have their benefits and drawbacks. By understanding the differences and discussing them with accountants/financial advisors, buyers and sellers can make informed decisions that align with their strategic goals and risk profiles, and lawyers can draft the acquisition documents to protect their client’s interests.

Contact our Corporate & Commercial team if you would like to discuss an upcoming transaction.