Price adjustment mechanisms: Locked Box vs. Completion Accounts
Locked Box vs Completion Accounts, two price adjstment mechanisms with some important differences to highlight. The price adjustment mechanism through closing accounts, known as Completion Accounts, responds to the impossibility of the parties to determine in advance the valuation and price that the company will have at the time of the closing of the transaction and the transfer of risk.
Hence, the parties agree on a provisional price based on reference financial statements and, against these, make the necessary post-closing adjustments. The result is a closing price adjusted to the reality of the company at that time.
This method has traditionally been the most widely used; however, the uncertainty as to the final price assumed by the parties between the reference period and the closing and the discrepancies arising from post-closing adjustments have led to the widespread use in recent years of a new pricing method known as Locked Box, which is based on the valuation of the company and the determination of a closed price at a given time with the transfer of the economic risk to the buyer at that date and before the transfer of the shares and, consequently, the payment of the price, legally takes place.
Locked Box vs. Completion Accounts: Completion Accounts
Comparing Locked Box vs Completion Accounts, we find that Completion Accounts is a variable price mechanism in which the parties negotiate a certain reference date and take the company’s financial statements as of that date to calculate the provisional price to be paid at closing, which will be subsequently adjusted. The seller assumes the risk of the evolution of the business until the closing, when it is transferred to the buyer.
Contractually, it is important that the parties agree on the accounting parameters to be taken into account post-closing for the calculation of the final price, understood as the provisional price adjusted in accordance with those parameters.
Normally, adjustments will be made on the basis of the net debt existing at the closing date when the valuation of the company has resulted in the enterprise value. In determining the net debt at closing, it will be compared to the net debt taken at the reference date and the difference will be subtracted from or added to the enterprise value to arrive at the equity value at closing.
However, the adjustment for net debt (debt – cash) is easily made up by the seller who, as we have said, remains in control of the company until closing and will want the closing adjustment to be either in his favor or as little in favor of the buyer as possible. Indeed, by simply delaying payment to suppliers or bringing forward the collection from customers, the seller can achieve an increase in the cash flow of the business and, therefore, a lower net debt at closing for the buyer to adjust.
Locked Box vs. Completion Accounts: Locked Box
As for the Locked Box, within the Locked Box vs Completion Accounts comparison, is a fixed price mechanism where the price of the company is calculated according to the value of the company on a reference balance sheet, normally audited and prior to the date of signing the sale (Locked Box Accounts).
From that moment on, the business risk and its economic effects (whether positive or negative) are transferred to the buyer even though, from a legal point of view, he has not yet acquired the company. The price agreed by the parties on the basis of the Locked Box Accounts will remain immutable and will not be subject to any adjustment either at the signing of the contract, at closing when it is paid, or subsequently.
However, this rule contains two exceptions:
- Cash outflows not allowed between the Locked Box Accounts and the closing date (known as Leakages)
- An interest rate that is usually agreed in favor of the seller to compensate for the time between the transfer of the business profits to the buyer (at the date of the Locked Box Accounts) and when the price is received (at closing).
At Letslaw by RSM, as commercial lawyers, we offer advice on price adjustment mechanisms and other personalised commercial advice adapted to the needs of companies. Contact us and we will be happy to help you.
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