Completion Accounts vs Locked Box: Evaluating Closing Mechanisms in M&A Transactions

17 March 2023

by: Zachary Cefaratti

 

In mergers and acquisitions (M&A), the closing mechanisms plays a crucial role in determining the final purchase price. Two common methods for settling the purchase price are completion accounts and locked box mechanisms. This article will discuss the advantages and disadvantages of each approach, factors to consider when choosing the most suitable option, and statistics about their prevalence in M&A deals.

Completion Accounts: Advantages and Disadvantages

Completion accounts are financial statements prepared at the closing of a transaction, reflecting the target company’s financial position at that point in time. The purchase price is adjusted based on the net asset value or working capital at completion.

Advantages:

• The completion accounts method provides both parties with an up-to-date and accurate representation of the target company’s financial position.
• The buyer and seller share the risk of any changes in the target company’s financial performance between signing and closing.
• Buyers may feel more confident in the transaction, as they pay for the actual financial position at completion.
• Completion accounts are more effective in transferring risk and return at completion

Disadvantages:

• The process can be time-consuming and costly, as it involves preparing and agreeing on the completion accounts.
• Disputes may arise between the buyer and seller regarding the preparation and interpretation of the accounts, leading to delays or additional costs. It is critical for the advisors to protect the sellers interest in a completion accounts deal, and various protections can be put in place such as escrow and clear metrics for true-ups.

Locked Box: Advantages and Disadvantages

In a locked box mechanism, the purchase price is determined based on the target company’s financial position at a pre-agreed date (the locked box date) and is not subject to adjustments. The buyer assumes the risk of changes in the target company’s financial performance between the locked box date and closing.

Advantages:

• The locked box mechanism simplifies and accelerates the transaction process by eliminating the need for completion accounts.
• The purchase price is fixed, providing certainty to both parties.
• Sellers can benefit from a faster transaction process and a potentially higher purchase price, as the buyer assumes the risk of any changes in financial performance.

Disadvantages:

• Buyers may be exposed to the risk of value leakage, market events or liabilities that arise between the locked box date and closing.
• The locked box mechanism requires a high level of trust between the buyer and seller, as the buyer relies on the historical financial information provided by the seller.

Factors to Consider in Choosing the Right Closing Mechanism

• Timeline: If a quick transaction is desired, a locked box mechanism may be more suitable, as it eliminates the need for completion accounts.
• Risk appetite: Buyers willing to assume more risk may prefer the locked box mechanism, while completion accounts provide a more balanced risk-sharing approach.
• Quality of financial information: If the target company’s historical financial information is reliable and well-maintained, a locked box mechanism may be more appropriate.
• Market conditions: Prevailing market conditions and industry norms may influence the choice of closing mechanism. With highly volatile businesses with prices which can swing rapidly based on exogenous factors, like upstream commodities businesses, completion accounts may be necessary.

Prevalence of Closing Mechanisms

According to the 2020 CMS European M&A Study, the locked box mechanism has become increasingly popular in recent years, with 53% of deals using this approach. In contrast, completion accounts were used in 47% of transactions. However, the prevalence of each mechanism varies across industries and regions, and these statistics should be considered as a general indication.

The choice between completion accounts and locked box mechanisms in M&A transactions depends on factors such as the desired transaction timeline, risk appetite of the parties involved, and the quality of the target company’s financial information. By carefully considering these factors and the advantages and disadvantages of each closing mechanism, sellers and buyers can make informed decisions and navigate the M&A process more effectively.

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