What is locked box?

The question: what is locked box?

"Locked box" is an alternative to a traditional completion accounts mechanism (familiar to advisors working under UK law) used in legal agreements when a target business is sold.

A traditional completion accounts mechanism:

- Is designed to be fluid: post deal a firm of auditors measures net assets for the target business. If actual net assets, as measured by the auditors, are less than previously-agreed target net assets, the seller will have to compensate the buyer;

- Takes time and is prone to argument and dispute. Potentially every item measured by the auditors, and every accounting treatment applied, could be questioned by either side. Because the audit and any argument happen after the sale, buyer and seller are left with price uncertainty.

Given the potential problems outlined above, a locked box mechanism replaces the fluid completion accounts mechanism with a "sticky" alternative. Only if, say, actual net assets prove to be 10% less than expected does the seller compensate the buyer. This is designed to deliver price certainty to both sides.

A locked box mechanism is not without its problems though. Net assets still need to be measured after the deal, there is plenty of scope for argument over actual net assets and a claim could still easily result. However, because of the "stickiness" of the mechanism, you would expect a reduced chance of claim.

Sceptics on our courses have commented: "accountants like completion accounts mechanisms because they create more work for them (completion accounts policies, post-completion audit) but lawyers like locked box because it's more work for them (drafting the mechanism)".

The reality is both mechanisms have their faults. A few more details are provided below:

- Locked box has been imported into the UK from the US as an attempt to get around the arguments that inevitably arise out of a traditional completion accounts adjustment;

- Locked box replaces a fluid "£ for £" adjustment mechanism where one side is bound to have to compensate the other for one where one side might have to compensate the other;

- Under locked box the seller guarantees a completion balance sheet which is typically an historic balance sheet (e.g. the last audited balance sheet or a very good management accounts balance sheet) plus the adjustment to net assets arising from profitably up until completion, less permitted adjustments e.g. an agreed pre-sale dividend;

- There is no completion accounts process. It is replaced with the risk of claim against the seller if the guaranteed balance sheet (less, say, 10%) is not delivered.

Where lawyers and accountants are involved arguments are still likely to result!

CPD training courses from FTA Ltd

Please click on CPD courses for more details of FTA's accredited course programmes for professionals, including our “negotiating big financial issues” CPD training course.

Strategies Within a Sale and Purchase Agreement

The question: what are some of the key strategies a seller can employ when negotiating a sale and purchase agreement?

This question relates to a question received on one of the courses we run where lawyers and corporate finance advisers consider key negotiations around "the numbers" in sale and purchase agreements constructed under UK law. Click on "financial issues" for more details about one of the CPD courses we run which deals with this area.

1. Debt balances: when calculating the value for shares consideration in the sale and purchase agreement, the seller could argue that balance sheet items are not debt (i.e. are not involved in the long term financing of the business). The seller could argue that these items shouldn't be deducted when moving from an initial headline debt-free-cash-free offer to the value for shares consideration. If debt items are not included and not deducted from the headline offer, shares consideration for the seller goes up.

2. Working capital: the seller could argue that the business has enough working capital. The seller could argue that the buyer should have known about working capital requirements for the business based on information previously released. This should help avoid a situation where a buyer tries to "chip" the sale price at the last minute, on the basis that the business does not carry enough working capital.

3. Target net asset value: the seller could argue that target net asset value should be referenced against an older balance sheet released early on in the transaction process, the same one the buyer referenced when they submitted their offer. Post deal completion auditors will measure the net asset value for the business. If actual net asset value, as measured by the audit, is relatively high compared to the target net asset value, the buyer will have to pay more to the seller.

4. Completion accounts: the seller could argue against the introduction of new accounting policies (for example, discounting old debtors) that might result in lower asset values as determined by a post-completion audit. If asset values are robust, actual net asset value (as measured by the audit) will compare favourably against target net asset value. There will be less chance that the seller has to compensate the buyer.

About FTA Ltd

FTA Ltd is a provider of finance-related CPD training courses to law, accountancy, banking and financial services professionals. See www.cpd-courses.org for further details.