Blog > corporate finance > Completion Accounts or Locked Box?
Dan James
30 May 2022

Completion Accounts or Locked Box?

In a typical sale and purchase transaction, a prospective purchaser will enter into Heads of Terms with a prospective seller at a non-binding agreed price for the shares of the business in question, which is called the “Enterprise Value”.

These Heads of Terms will often stipulate that the acquisition will be on a cash-free, debt-free basis with normal levels of working capital. This is generally undefined at this stage and rarely quantified, leaving the sellers unclear on what that means for the overall cash consideration.

This terminology means that the Enterprise Value will be adjusted up for all cash items on the balance sheet, down for all debt items on the balance and either up or down depending on whether net working capital is either higher or lower than an agreed ‘normal’ target level. In aggregate, this will either increase (Surplus Cash) or decrease (Net Debt) the Enterprise Value to arrive at the Equity Value, which represents the actual cash proceeds that will be paid for the shares.

There are many nuances in constructing the Enterprise Value to Equity Value bridge, including which items reflect cash (and are they recoverable or trapped), which items reflect debt (as opposed to working capital), and what is a ‘normal’ level of working capital. These are all key focus areas of the financial due diligence that will seek to present a fair and balanced view of a pro forma completion statement.

There are then two widely accepted methods in the UK for adjusting the Enterprise Value to the Equity Value; “Completion Accounts” and “Locked Box”, which we explore further in this blog.

Completion Accounts

The Completion Accounts method sets out the initial consideration in the Sale & Purchase Agreement but the final price payable is determined after the transaction has completed based on the actual balance sheet of the business sold as at the Completion Date.

The SPA will have a specific schedule dealing with the preparation of the Completion Accounts and the principles upon which they should be prepared, along with definitions to prescribe how the pro forma completion statement is constructed.

The main advantage of this methodology is that it allows for adjustment of the cash proceeds (up or down) based on the balance sheet up to the Completion Date. However, given that there remains uncertainty of the final cash proceeds post-completion it does leave open the possibility of dispute, which if parties are continuing together in the business can be unhelpful for the building of trust and rapport with the rolling shareholders.

Locked Box

The Locked Box method, in terms of the formulation of the completion statement, is the same as Completion Accounts but it is applied to an actual balance sheet prior to the Completion Date (the Locked Box Date) rather than the actual completion balance sheet. This provides certainty for all parties on the final cash proceeds prior to closing the transaction and there is no further work required post-completion to adjust the price other than perhaps confirming the “profit ticker” or “value accrual” adjustment. This adjustment is a mechanism to give value to the sellers for the cash profit generated in the period between the Locked Box Date and the Completion Date, when the business remained under their ownership.

In this instance, the SPA will focus on defining items of Leakage, both Permitted and Non-Permitted, which prescribes expected behaviours in the period between the Locked Box Date and the Completion Date; for example, that no dividends will be paid to shareholders.

The other benefit of the Locked Box for the purchaser is that the Locked Box balance sheet can be fully scrutinised through due diligence as it represents a date in the past. However, if for some reason the purchaser has not been able to perform full due diligence then the Locked Box method may not be appropriate as there will be little, if any, opportunity to adjust the proceeds post-completion.

It is important to keep the Locked Box Date as close to the expected Completion Date as feasible (e.g. for the preparation of fully closed and robust management accounts) so that adjustments for profit tickers and leakers are minimised and de-risked. Typically the Locked Box Date would be within 2-3 months of Completion and generally not longer than 6 months.

If you would like any advice or further information on deal completion methodologies, please contact Dan James for an informal chat.

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