One of the key issues to be addressed in M&A transactions is the determination of the purchase price when signing of the share purchase agreement ("SPA") and the completion of the deal do not coincide. Depending on the specific characteristics of the transaction, the aforementioned specified dates can be weeks or even months apart. As companies remain active between signing and completion, their value is subject to change during this period. Since title to shares is only transferred upon closing, the purchase price should be determined then. The challenge discussed here is therefore how to solve the issue of the uncertain price on completion at the time of signing.
There are two widely accepted completion mechanisms in M&A transactions in order to tackle this challenge, which will be discussed below, i.e.:
- locked box mechanisms;
- completion accounts.
We will also discuss hybrid systems, combining features of both mechanisms, which are becoming increasingly popular.
A locked box mechanism allows parties to agree on a fixed price at signing. This price is based on the elements of the target company known at that time – often based on interim accounts that have been discussed and agreed between the parties. Simultaneously, the parties agree that the elements used for the determination of the purchase price are "locked". At the initiative of the acquirer, the vendor often undertakes not to let value leave the target company (e.g. by way of issuing a dividend or extracting management fees).
Should value, however, leave the target company during the completion period, so called "leakage" occurs. Typically, parties agree that certain leakage (usually leakage that has occurred outside the vendor's control) is "permitted". All other leakage should be reimbursed by the vendor to the acquirer at completion on a euro-for-euro basis – often on the basis of a reduction of the purchase price. Reversely, value accrual during the completion period can be compensated for by an increase of the purchase price at completion.
The locked box mechanism is generally considered to be vendor-friendly because it provides for price certainty up front rather than being subject to a post-completion adjustment at a later stage. Important considerations are (i) the level of protective measures for the acquirer (e.g. representations and warranties on the interim accounts, (ii) the provisions on "permitted leakage" and (iii) clarity on the methods used to compare completion accounts to the interim accounts.
When using the completion accounts mechanisms, at signing parties agree on a provisional purchase price. This purchase price may be payable at signing but is often postponed until the completion date. At the completion date, the provisional purchase price will be adjusted based on the (financial) situation of the company at completion. In order to avoid re-negotiations over the purchase price at completion, parties most often predetermine the adjustment methods at signing. Typical adjustment methods include:
- net asset / debt adjustments;
- working capital adjustments; and / or
- capital / revenue expenditure adjustments.
As the price is less certain at signing compared to locked box mechanisms, completion accounts are generally considered to be less vendor-friendly. However, if the vendor is very confident that the value of the target company will increase during the completion period, this mechanism may be more interesting for him as well.
Important considerations when using completion accounts include (i) inserting a clear comparison method for financial figures at signing and closing, (ii) determining the adjustment methods and (iii) agreeing on the right representations and warranties on certain parameters both at signing and completion.
Lately a new trend has emerged that enables parties to combine features of a locked box mechanism with completion accounts to provide for a tailor-made completion mechanism in transaction documentation. One of the options could be using a completion accounts mechanism for a part of the period between signing and completion, with a locked box structure applied thereafter. This can be particularly useful in the following situations:
- when parties mainly agree to use the locked box mechanism to provide for more price certainty, but due to specific uncertainties (e.g. the impact of certain measures is still unknown) want to apply a price adjustment after a short period before "locking the box"; or
- when the purchase price adjustment is linked to a date when annual financial statements are prepared and completion takes place later; or
- when the target company is unable to prepare completion accounts on the completion date (e.g. completion mid-month), which would result in unreliable accounts on the completion date.
The implementation of locked box, completion accounts or hybrid mechanisms should be carefully considered for every specific transaction. Particular attention should also be paid to protective provisions or warranties in the transaction documentation for each of the completion mechanisms.
Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.