The acquisition price for a business is typically agreed on a “debt and cash free basis”, whereby the headline price or “Enterprise Value” is adjusted upwards or downwards for net cash or net debt in the business. This adjustment can have a significant impact on the final acquisition price.
Generally there are two widely accepted mechanisms for adjusting the Enterprise Value: “Completion Accounts” and “Locked Box”. The mechanism is usually agreed as part of the initial negotiations between the buyer and seller.
A Locked Box mechanism has the advantage of setting the final acquisition price prior to completion and, whilst there may be significant additional costs with professional advisors in agreeing Completion Accounts, it can provide the Buyer will added protection. Whilst there has been a trend towards using a Locked Box in recent years, with almost 90% of deals at HMT using a Locked Box pre COVID-19, transactions have increasingly moved towards using Completion Accounts over the last year.
A key factor in the shift is considered to be the extra certainty given by the completion accounts mechanism in the COVID climate, but how long this shift is maintained is open to debate.
Completion Accounts are typically considered to be more favourable to the buyer, with the economic risk of the target only transferring to the buyer upon completion of a transaction, which buyers consider particularly important during times of uncertainty, such as the pandemic situation over the last year. .
Furthermore, Completion Accounts provide additional comfort to a buyer when there is a significant amount of time between the date at which financial due diligence is being performed and the expected completion date, as has been the case on a number of recent deals at HMT which paused during the pandemic..
On the other hand, a Locked Box mechanism is seen to be more favourable to the seller, as the buyer ultimately taking on the risk of how the target performs between the locked box date and completion, with the seller typically receiving an agreed “profit ticker” during this period. In addition, sellers tend to prefer a locked box mechanism, as it provides them with more certainty with locked box accounts being agreed in advance of a transaction completing.
A fundamental difference between the two mechanisms is that the Locked Box is negotiated prior to completion meaning if one party does not like the outcome, they ultimately have the ability to walk away from the deal. With this knowledge, a reasonable outcome for both parties is usually negotiated.
Alternatively, Completion Accounts are agreed post completion. As such, if there are areas of disagreement, a formal legal process will have to be followed to determine the final acquisition price. This carries a risk of parties potentially falling out. Where the seller remains key to the business going forward (i.e in an on-going management role), this is not a positive way to start a new relationship.
In summary, the completion mechanism used is typically determined by the experience and negotiating power of both the buyer and seller, and hence it is more important than ever that both buyers and sellers consider the impact of completion mechanisms at the start of each transaction. A thorough financial due diligence process should mitigate the extra protection provided to the Buyer by way of Completion Accounts and so should be factored into the decision on choice of mechanisms.
Our Transaction Services team are ready to help you navigate through any stage of a transaction process you are contemplating, so please do get in touch with us on 01491 579740 or alternatively on 07966 665 126.