Locked Box vs Completion Accounts
How do these two options work when you are selling a company? And which one might be right for you?
When an acquirer makes a formal offer to buy your business, the price is always linked in some way to your company’s financial performance. Whether the valuation has been based on the Net Asset Value shown on your balance sheet, or a multiple of your EBITDA, your accounts are the starting point for agreeing a price.
But once you have accepted a formal offer, the due diligence and completion process will take several months. During that time, your company will continue to trade and its financial position will change.
The end result is that the value of your business at completion will be different to the value at the time you received the original offer.
This creates some risks and uncertainties for both buyers and sellers. However, there are two different mechanisms that are commonly used to resolve the issue.
The most common solution is for the sale price of a business to be dependent on Completion Accounts – accounts that are specially prepared as at the date of completion.
To take a simplified example, consider an acquirer who agrees to pay 8x EBITDA for Company A. During the due diligence process, the buyer and seller agree a figure of £1m, as an estimate of Company A’s likely EBITDA for the 12 months to the completion date.
The buyer therefore pays the seller £8m at completion – 8x the £1m EBITDA estimate.
After completion, accurate Completion Accounts are prepared, based on principles stipulated in the final Share Purchase Agreement (SPA). The Completion Accounts Profit & Loss statement reveals that Company A actually achieved EBITDA of £1.1m. The buyer therefore owes the sellers a further payment of £800,000 (8x the additional £100,000 of EBITDA).
For the buyer, the main advantage of the Completion Accounts approach is that it reduces the risk of overpaying for a business. If the business does not perform as expected between the agreement of the offer and completion, then the price paid for the business is reduced accordingly.
The Completion Accounts approach also allows sellers to capture the benefit of any additional value they create between accepting the offer and completing the sale of the business. But it is also true that Completion Accounts create uncertainty about the proceeds that the sellers will receive. As mentioned above, if performance is poor in the run up to completion, the final sale price will be lower than the sellers had hoped for at the time of the offer.
‘Locked Box’ transactions provide an alternative to the approach described above.
A locked box offer is based on the target company’s financial position as at the date of the offer, factoring in an accurate assessment of all line items on the P&L and Balance Sheet, including cash, debt and working capital.
After the offer is signed, the business continues to trade (and remunerate its employees and shareholders) in the normal way. But the performance of the business between signing the offer and the completion date will not alter the agreed sale price, which is written as a fixed amount in the SPA.
This mechanism means that the buyer bears the risk of a downturn in performance, but also stands to benefit from any additional value that may be created prior to completion. The buyer will protect its position by adding ‘leakage’ clauses to the SPA, designed to prevent the seller from releasing money to themselves outside the normal course of business.
A locked box agreement is often combined with a ‘profit ticker’. The ticker is best thought of as an additional payment, which shifts the benefit of profits generated between signing the offer and completing the deal back to the seller.
Depending on the nature of the business, tickers can be calculated using management accounts to arrive at a profit-after-tax or cash generated figure, or it may be appropriate to simply agree a daily amount that is added to the purchase price every day until completion.
Buyers are generally happy to agree a profit ticker, since it keeps the sellers motivated to maximise the performance of the business prior to the completion date.
The choice between Completion Accounts and Locked Box will depend on the buyer’s and seller’s preferences, the nature of the business, and the expected timing of the transaction. If you are working with an M&A adviser, they should support you through the negotiation process and agree an appropriate mechanism.