Deal Structuring
Most businesses are typically sold on what is known as a cash and debt free basis: an offer will typically start with an enterprise value that the buyer and seller agree for the business. Let's arbitrarily say that figure is £5m. This will ordinarily be made on a cash and debt free basis, meaning plus all of the cash and minus all of the debt. If that calculation results in a positive figure, it gets added to the consideration. If it's a negative figure, it comes off the total. So in this example, if we determine surplus cash is £1m, the amount paid out will be £6m. That final figure is known as your equity value. There are also some nuances related to “normalised working capital”, which you'd be expected to leave behind. If you'd like to learn more about this, we'd suggest checking out our article on Cash and Debt Free.
So where do locked box and completion accounts mechanisms come in? Effectively, these are two different ways of fixing the equity value in a business sale, and the choice between them decides who benefits from how the business performs between agreeing a deal and the money actually changing hands, and how much room there is for a dispute afterwards.
Under completion accounts, buyer and seller agree a price at signing based on an estimated surplus cash or net debt position, then prepare an actual set of accounts as at the completion date itself (usually within thirty to ninety days of completion), and true up the price to reflect the real cash, debt and working capital position on the completion day. So if the estimated surplus cash is £800k, you'll get this on the day of completion. Once the completion accounts are prepared, if it turns out the surplus cash figure was actually £1m, you'll get the extra £200k.
This provides the most accurate and up-to-date cash and debt free position and means the seller receives full value for any profit earned in the business right the way up to completion. The trade-off is a period of exposure to how those closing accounts get prepared and reviewed, which is where most disputes under this structure arise. This is why it is crucial to have a legal and commercial adviser working in tandem to ensure the final agreement provides a clear structure on how those accounts will be prepared and what happens in the event of a dispute.
A locked box works the other way round. The equity value is fixed upfront by reference to a set of accounts at a set date (the locked box date), often the most recent audited or management accounts before the deal is signed, and there's no adjustment once the deal completes, whatever happens to cash or working capital in between. Because there's no later adjustment, the buyer instead needs protection against value being taken out of the business between that date and completion, known as leakage. This covers things like dividends, unusual bonuses, waived debts or related-party payments, which the seller warrants hasn't happened (beyond agreed permitted leakage such as normal salaries or specifically agreed amounts). In effect, if surplus cash is agreed at £1m, you can't also dividend out £1m after the locked box date and get the money twice.
Those who favour a locked box tend to do so for the certainty it offers: the price is fixed at signing, there's no drawn-out post-completion reconciliation, and the exit is clean. The trade-off is that if the business makes significant profit between the locked box date and completion, that upside stays with the buyer rather than the seller. This can be mitigated if your adviser negotiates a cash ticker for you, which is designed to compensate for this lost value. It's also really important to have an adviser who is on the ball with this calculation, since there'll be no chance to revisit it at a later date if something gets missed.
Which mechanism suits a given sale usually comes down to how confident both sides are in the business's trading between now and completion, and how quickly the deal is expected to close. Neither is inherently the right answer, and the choice is often as much about appetite for post-completion process as it is about price. Whichever mechanism is used, what matters most is that the definitions, the leakage carve-outs or the working capital target, are agreed commercially and drafted tightly, since vague wording here is where most disputes end up starting.
If you're thinking about or in the process of a sale and would like to have a chat about how we can help, we're always happy to have a conversation.
This article is general information only and is not legal or accounting advice. Pricing mechanisms and their drafting should always be reviewed with your own solicitor and accountant before you agree terms.