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12 September 2018
What is a 'locked box'?
How does a locked-box mechanism work?
What does it mean for buyers and sellers?
What is 'leakage' and what are typical leakage protections?
For the sale of a company using a European-style share purchase agreement governed by English law, the use of a 'locked box' as the seller's preferred pricing mechanism is now more commonplace than the traditionally popular closing accounts.
Traditionally, English law-governed share purchase agreements have provided for the purchase price to be varied by reference to the net assets of the target as at closing or sometimes by reference to some other measure, such as working capital.
Following closing, the buyer and its accountants would normally draw up a set of closing accounts used to calculate the net assets, with a pound-for-pound adjustment to the purchase price, to the extent that the actual net assets exceeded or were less than a target figure agreed by the parties prior to signing.
The 'locked box' is an alternative pricing mechanism to closing accounts, under which the parties agree a price payable for the target based on a balance sheet (the locked-box balance sheet) that is drawn up and settled between the parties on an agreed date in advance of signing (the locked-box date). This date is often the previous financial year-end date or the date of the most recently available management accounts.
Private equity sellers have driven an increasing trend, particularly in the secondary buy-out market but more generally in competitive sale processes, towards locked-box deals (or fixed price deals as they are also known).
For a private equity seller, the attraction of the locked-box pricing mechanism is that:
In other words, this mechanism prevents a buyer from using the closing accounts process (where the buyer would ordinarily expect to have control of the relevant information) to renegotiate price.
In European deals, a locked-box mechanism is commonly stipulated up front in controlled auctions or other situations where a seller is in a position to dictate the terms of the share purchase agreement.
In general terms, the mechanism works as follows:
In addition, a buyer may also be required to agree to repay or procure the target's repayment of indebtedness, which may include the repayment of shareholder loans.
For a seller, key considerations regarding the use of a locked-box mechanism will include whether:
For a buyer, key considerations regarding the use of a locked-box mechanism include whether:
Ultimately, with the use of a locked-box mechanism, a buyer will need to become comfortable through its due diligence investigations with the locked-box balance sheet (this may require more financial or accounting due diligence than that undertaken when the buyer has the comfort of a post-closing true-up).
To assist, a buyer will usually seek a warranty as to the accuracy of such balance sheets, although private equity sellers have been increasingly successful in limiting the warranties and indemnities that they give. A buyer will also require a number of protections in the share purchase agreement to prevent the seller from being able to extract value (referred to as 'leakage') from the locked-box date to closing, other than any pre-agreed value extraction that can be factored into the purchase price (referred to as 'permitted leakage').
'Leakage' typically includes (other than agreed as permitted leakage):
The leakage protections referred to above (and given by the seller at signing) generally take the following forms:
For further information on this topic please contact Will Pearce or William Tong at Davis Polk & Wardwell London LLP by telephone (+44 20 7418 1300) or email (firstname.lastname@example.org or email@example.com). The Davis Polk & Wardwell website can be accessed at www.davispolk.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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