- Unlocking the locked box
Unlocking the locked box
Unlocking the locked box28th January 2021 - Published by Kuits Corporate team
What is a locked box?
A locked box is a mechanism through which the seller and buyer in a company sale and purchase agree the price payable for the business, generally based on a balance sheet, known as the locked box accounts, drawn up and agreed at a date, known as the locked box date, in advance of completion.
What are the features?
Typical features of a locked box mechanism are:-
- Agree price in advance: The parties negotiate and agree a fixed price in advance of completion based on the locked box accounts. A locked box therefore sets the price based on historical financial information and there is no post-completion adjustment to the price. Whereas the alternative price mechanism of completion accounts establishes the price by reference to the financial position of the business as at the date of completion. This is done by carrying out a post completion accounting exercise with further payments then being required to reflect the determined price if too much or too little was initially paid at completion.
- Warranties: To protect the buyer, the seller typically agrees to provide the buyer with comfort as to the integrity of the locked box accounts by giving warranties that they are accurate.
- Interest: The agreed price is paid at completion, but the seller will not have had the benefit of the businesses’ profits from the locked box date. To compensate the seller in relation to this, the buyer may agree to pay interest or a daily profit charge in respect of the period from the locked box date to completion.
- Leakage: The seller usually confirms to the buyer that there have been no dividends, payments or other leakage from the business, save for agreed permitted leakage which typically covers ordinary course payments/salaries and so on, into the hands of the seller or persons connected to it since the date of the locked box accounts.
- Buyer risk in period to completion: Economic upside or downside in the business are for the account of the buyer from the locked box date.
The use of locked boxes have long been favoured by sellers given the certainty as to the price they provide and they are often commonplace in a seller-friendly market. Over recent years, locked boxes have been increasingly utilised by sellers and buyers instead of the alternative of completion accounts.
What are the benefits?
The benefits of a locked box mechanism for both seller and buyer are:
- Certainty as to the price: The locked box structure delivers price certainty as when the deal is signed, both parties know exactly what the price is. This often proves attractive not only to sellers, who know there can be no nasty surprises for them following completion, but also for the buyer, who can draw a line under the deal process at completion, rather than dealing with completion accounts afterwards, and straight away focus fully on running the business.
- A simpler process: Whilst the buyer may well want to carry out more extensive financial due diligence for a locked box transaction to make sure it is comfortable with the locked box accounts and price agreed, overall the process is usually more straightforward.
- A simpler share purchase agreement: The share purchase agreement does not require the detailed provisions dealing with the completion accounts process which can often run to numerous pages and require detailed negotiation by the parties’ legal and financial advisers.
- Avoids the cost of a completion accounts exercise following completion: Even if the completion accounts are swiftly agreed between the parties, this still be more costly than agreeing the locked box accounts. This is because the completion accounts process must be formally and carefully carried out in accordance with the procedure set out in the provisions of the share purchase agreement. Further, if the completion accounts cannot be agreed between the parties and there is a dispute, the costs are likely to be much higher than a locked box deal and in the most contentious cases could even involve third party independent experts and court proceedings.
With the uncertainty of the impact of Brexit and the volatility in the economy due to COVID-19, it is possible that we will start to see more of a move away from the locked box trend. Buyers are more likely in this climate to require protection from overpaying for the business based on its position at completion and against any downturn in the business post-completion. It is likely that sellers may therefore increasingly need to consider accepting completion accounts structures and/or deferred consideration or earn-out structures, where all or part of the purchase price will be calculated by reference to the future financial performance of the target company.
Get in touch with a Corporate lawyer in Manchester
Our expert Corporate team can guide you through the legal aspects of the process of a company or business sale and purchase including the pricing mechanics. Please contact Senior Corporate Associate Helen Mather on 0161 838 8183 or email firstname.lastname@example.org for advice.