21.09.2021

M&A Pricing Mechanics: Completion Accounts vs Locked Box

A critical period in the timeline of any M&A share transaction is the period between signing the Share Sale and Purchase Agreement and completion.

During the period between signing and completion, a buyer will be keen to ensure that the target business continues to operate as usual and without any events transpiring which could have a detrimental impact on the target’s operations or value.

A buyer will look to manage this risk in a number of ways.   From a contractual perspective, in addition to imposing certain standard covenants which restrict the seller’s behaviour as regards the target post-signing, pricing mechanisms can (to varying degrees) help avoid any significant disconnect arising between the price paid and the actual value of the target as at completion of the deal.

Our business advice team takes a look at two types of pricing mechanisms used in M&A share transactions – the completion accounts mechanism and the locked box mechanism – as well as the relative benefits of each approach for parties to an M&A share transaction. 

Completion Accounts Mechanism

In the context of an M&A share transaction the completion accounts mechanism is a common approach.  In broad terms, this involves a new set of financial statements being prepared with respect to the target entity specifically for the purposes of the sale.  Often a deal may provide for an initial completion payment and a subsequent adjusted and final payment, based on the specifically prepared completion accounts.    In this way, the final price paid (sometimes by way of ‘top up’ by the buyer or alternatively by repayment by the seller) is retrospective and based on the target’s actual figures as contained in the final completion accounts.

Specific timelines, procedures and associated definitions for the completion mechanism will need to be agreed upon in the transaction documents, noting that generally this mechanism allows for disputes or challenges to the interpretation of the completion accounts (often with the involvement of an independent expert) and therefore the process does have the potential to extend the timeframe for conclusion of a transaction.  Often a contentious area of the completion accounts, which is routinely challenged during this process, is the calculation of the working capital amount for the target. 

For a buyer, particularly one which has not undertaken significant due diligence on a target, the completion accounts mechanism helps to provide a degree of comfort that the ensuing price adjustment to be made is based on a true, accurate and current ‘snapshot’ of the business as recorded in the completion accounts, even if it takes some time for this process to be finalised post completion. 

Locked Box Mechanism

Conversely, in a locked box scenario the purchase price is calculated based on a balance sheet of the target which is dated prior to the deal completing.  The purchase price is fixed (or ‘locked’) with reference to the earlier balance sheet date.  In addition, from the locked box date the seller agrees not to engage in any activities which would result in any ‘leakage’ – which typically covers any transactions, payments or disposals resulting in the shifting of value outside of the target.  The seller will typically look to negotiate certain ‘permitted leakage’ carve outs to the leakage provisions.

The locked box approach is helpful to sellers looking for clarity in pricing prior to completion.  The locked box approach avoids lengthy or ongoing discussions between the parties around completion accounts and any associated adjustments of price arising from such accounts.  This is particularly useful for sellers that are transacting in the context of a competitive bid or auction process, as the pricing mechanism gives a degree of certainty in the purchase price (as they are effectively pin pointing the pricing based on the locked box date prior to completion), meaning it is easier for bids to be compared against one another. 

From the buyer’s perspective, as it does not have the comfort of the final adjustment accuracy which would otherwise be provided by a set of updated completion accounts, it is crucial for the buyer to ensure that there are strong protections in place preventing leakage from the locked box as well as adequate warranties, covenants and indemnities to ensure the target’s value is not eroded between the locked box date and the date of completion for the deal.

Other Considerations

Competing commercial interests of buyers and sellers will lead to different price mechanics being used in different instances – and decisions are often dictated by the relative negotiating positions of the parties and the overall deal structure.   In addition to a consideration of whether to use a completion accounts or a locked box approach, parties may elect to use other pricing mechanisms to structure payments including deferred consideration, earn outs and escrow arrangements.  As with all M&A transactions, careful structuring of the deal and the use of pricing mechanics is one of a number of areas to address in the deal context to ensure a satisfactory outcome for both parties.  

Hesketh Henry regularly advises clients on domestic and cross border M&A transactions.  Should you require further information, or wish to discuss in more detail, please contact our business advice team.

Do you need expert legal advice?
Contact the expert team at Hesketh Henry.
Kerry
Media contact - Kerry Browne
Please contact Kerry with any media enquiries and with any questions related to marketing or sponsorships on +64 9 375 8747 or via email.

Related Articles / Insights & Opinion

Money stack black and white
Income is classified as relationship property – surprised?
For all couples, embarking on the journey of building a life together involves not only love and commitment but also financial considerations.  As you navigate through shared finances, it’s imp...
26.03.2024 Posted in Private Wealth
Forestry Unsplash ruben hanssen wl ylTCM
Forestry: Regulatory Roundup March 2024
The challenging economic environment for New Zealand’s forestry industry continues, with China’s demand for our logs remaining subdued. Moreover, in addition to the change in Government, t...
25.03.2024 Posted in Forestry & Property
solar
OIO Spotlight: Solar projects, exempted interests and farmland considerations
As New Zealand renewable energy developments continue to attract interest from global investors, we take a look at some recent approaches of the Overseas Investment Office in assessing consent require...
BCC Trade Credit v Thera Agri Capital: Policyholder Successful Against Credit Insurer in Australian Court of Appeal Decision
When applying for trade credit insurance, a prospective insured will typically provide information on the financing arrangements that will form the basis of cover. Where there is deviation from these ...
05.03.2024 Posted in Insurance & Trade and Transport
iStock
Parker v Magnum Hire: A new era of personal grievance remedies awarded in the Employment Relations Authority?
If you heard a sudden loud noise last week – no it wasn’t a jet plane flying overhead, it was the gasp of employment lawyers across New Zealand when the Employment Relations Authority published it...
26.02.2024 Posted in Employment
employment dictionary website
Banding together: the Court’s new approach to awards for injury to feelings
One of the key remedies available to an employee who has successfully established a personal grievance in the Employment Relations Authority (Authority) or the Employment Court (Court) is compensation...
23.02.2024 Posted in Employment
Trust liability under the Health and Safety at Work Act
WorkSafe New Zealand v RH & JY Trust & ors
21.02.2024 Posted in Health & Safety & Private Wealth
SEND AN ENQUIRY
Send us an enquiry

For expert legal advice, please complete the form below or call us on (09) 375 8700.