A critical period in the timeline of any share merger and acquisition transaction is the period between the signing of the share purchase and purchase agreement and the conclusion.
During the period between signing and completion, a buyer will ensure that the target business continues to operate as usual and without any events occurring that could negatively impact operations or the value of the business. target.
A buyer will seek to manage this risk in several ways. From a contractual point of view, in addition to the imposition of certain standard covenants which restrict the seller’s behavior towards the post-signature objective, the pricing mechanisms can (to varying degrees) make it possible to avoid any significant disconnect between the price paid and the actual value of the objective as at the conclusion of the transaction.
Our business advisory team examines two types of pricing mechanisms used in M&A stock transactions – the closing accounts mechanism and the locked box mechanism – along with the relative benefits of each approach for the parties. to a merger and acquisition share transaction.
Mechanism of completion accounts
In a merger and acquisition transaction, the closing accounts mechanism is a common approach. In general terms, this involves a new set of financial statements being prepared in respect of the target entity specifically for the purpose of sale. Often, an agreement may provide for an initial completion payment and an adjusted and final final payment, based on the specifically prepared completion accounts. In this way, the final price paid (sometimes by way of “top-up” by the buyer or even by reimbursement by the seller) is retrospective and based on the actual figures of the target as they appear in the completion accounts. final.
Timelines, procedures, and associated definitions for the completion mechanism will need to be agreed upon in the transaction documents, noting that generally this mechanism allows for disputes or challenges in the interpretation of completion accounts (often with participation independent expert) and therefore the process has the potential to extend the time frame for concluding a transaction. Often a contentious area of completion accounts, which is regularly disputed during this process, is the calculation of the amount of working capital for the target.
For a buyer, especially a buyer who has not performed significant due diligence on a target, the completion accounts mechanism helps provide a certain degree of comfort that the resulting price adjustment is based on a true, accurate and current ‘snapshot’ of the deal as recorded in the completion accounts, although it takes some time for this process to be finalized after completion.
Locked box mechanism
Conversely, in a locked box scenario, the purchase price is calculated based on a target’s balance sheet dated before the transaction is closed. The purchase price is fixed (or “locked in”) from the previous closing date. In addition, from the foreclosure date, the seller agrees not to engage in activities that would result in “leakage” – which typically covers transactions, payments, or assignments resulting in a transfer of value outside. of the target. The seller will generally seek to negotiate certain exemptions from “permitted leaks” for the leakage provisions.
The locked box approach is useful for sellers looking for price clarity before completion. The locked-box approach avoids lengthy or ongoing discussions between parties regarding completion accounts and any associated price adjustments resulting from those accounts. This is especially useful for sellers who trade in the context of a competitive bid or auction process, as the pricing mechanism provides some degree of certainty about the purchase price (as they effectively determine the price according to the date of the locked box before the completion), which means that it is easier for the bids to be compared with each other.
From the buyer’s point of view, since he does not have the comfort of the precision of the final fit that would otherwise be provided by an updated set of completion accounts, it is crucial for the buyer to s ” ensure that there are strong protections in place to prevent the leakage of the as well as adequate guarantees, commitments and indemnities to ensure that the value of the target does not erode between the date of the locked box and the date of conclusion of the transaction.
Competing business interests of buyers and sellers will result in the use of different pricing mechanisms in different cases – and decisions are often dictated by the relative negotiating positions of the parties and the overall structure of the agreement. In addition to the desirability of using a completion accounts approach or a locked-box approach, parties may choose to use other pricing mechanisms to structure payments, including deferred consideration, top-ups. pricing and escrow agreements. As with all M&A transactions, careful structuring of the transaction and the use of pricing mechanisms is one of the many areas to be addressed in the context of the transaction to ensure a satisfactory outcome for both parties. .