In recent M&A deals, we’ve seen a continued desire from both buyers and sellers to fix all elements of transaction cost. In order to avoid post-completion equity price wrangling (via the completion accounts process), if you ‘lock the box’ by reference to a historical balance sheet (the locked box accounts) you are signing up to a fixed price deal at completion.
What are the advantages?
Simplicity and certainty are the key drivers here; the price negotiation takes place before completion, with the price being fixed on completion, subject to any breach of the ‘leakage’ warranty (more about leakage below). The pricing mechanics are the same as for a completion accounts process but the timing differs. With a completion accounts process the parties negotiate the parameters for preparing and agreeing a set of completion accounts post completion. A standalone schedule in the sale and purchase agreement contains the complex drafting and the parties then adhere to this process post completion.
The locked box mechanic is simpler. By completion the purchase price is fixed (having taken into account any agreed adjustments). As a result the drafting in the agreement is simpler too.
Watch out for leakage
Since the locked box date will be a certain period of time before completion, the sellers will agree to indemnify the buyer for any value which has leaked from the box between the locked box date and completion to the benefit of a seller. This is known as leakage and will be widely defined in the agreement.
Each seller will confirm that they (and their connected parties) have not received, consented to or created, and do not have knowledge of, any leakage. This confirmation is given on an indemnity basis so that the buyer will be able to recover on a £ for £ basis to the extent that the locked box warranty is breached (i.e. there has been any leakage). A buyer will have a fixed period of time to bring a claim under the leakage indemnity (usually somewhere between 3-12 months), but should consider how it will test for leakage before agreeing a time period.
There will also be a list of items which will be excluded from the definition of leakage and therefore not subject to the leakage indemnity, known as ‘permitted leakage’. The list of permitted leakage is agreed before completion and any price reductions arising are factored into the agreed purchase price.
What’s not to like?
There are circumstances where it is not appropriate (for example, a volatile business may deteriorate in the period between the locked box date and completion when the buyer is on risk) or possible (perhaps there is not enough time for a buyer to get comfortable with the locked box balance sheet) to consider a locked box approach, but for the time being the consensus appears to be that the parties should always consider whether it is an option.