Locked Box: a Worked Example of Price and Leakage

Between agreeing a sale and completing it, a business keeps trading. Someone has to own the profit, the loss and the cash it makes in that gap. Completion accounts settle it after the event by measuring the balance sheet on the completion day. A locked box settles it in advance: the parties choose a recent balance sheet, usually one that has been audited or reviewed, agree the equity price from it, and from that date the economic ownership passes to the buyer, although the seller still controls the business until completion.

That arrangement only works if the seller cannot empty the box in the meantime. So the sale agreement lists what may not happen: dividends, management charges to the seller's group, bonuses tied to the sale, the seller's deal costs paid by the business, debts owed by the seller waived, assets passed to related parties at less than their value. Any of these is leakage. Items the buyer has agreed to, such as ordinary salaries or a scheduled fee for services the seller's group still provides, are permitted leakage, and they are allowed for in the price.

Two features vary from deal to deal. The first is value accrual, sometimes called a ticker: because the buyer receives the profits from the box date but pays only at completion, the seller may negotiate a daily amount, or interest on the price, for the days between. The second is the claim period and the security for the promise: the buyer usually has a fixed number of months after completion to claim leakage, and may ask for part of the price to be held back, since a seller that has distributed the proceeds is hard to recover from.

A mattress and bedding manufacturer, constructed for this page like every figure in it, is sold by a family holding company. The box date is 31 March, the price is agreed at US$30.0m on its balance sheet that day, and the agreement adds value accrual of US$5,000 a day to completion. Permitted leakage is the holding company's fee for shared payroll and IT, US$40,000 a month, which the buyer allowed for in the price. Completion is on 31 August.

The buyer paid what it agreed and owns a business with US$0.6m less cash than the price assumed. It can recover the money, but only by claiming against the seller, months later. The permitted fee is not a claim: the buyer agreed to it and priced it. The numbers are the example's, not a market norm.

The buyer's lender reads the same lines differently. Its term loan was sized on the 31 March balance sheet and the buyer's model of cash at completion, so the business starts with US$0.6m less liquidity than the credit paper showed. The facility agreement treats recoveries under the sale agreement as a mandatory prepayment above a small threshold, so when the seller repays, the money goes to the bank rather than back into the business.

Completion accounts measure the business on the completion day and move the price afterwards, up or down. A locked box measures it on an earlier day and does not move the price at all; the only adjustment is a claim for leakage, which runs one way, from seller to buyer. The buyer of a locked box therefore takes the trading risk of the gap, good or bad, and relies on its diligence of the box balance sheet. The buyer under completion accounts takes the risk of a dispute about the accounts afterwards.

Locked boxes are common in the UK, where many sellers prefer the certainty, and are increasingly used in Australia and New Zealand, where completion accounts have long been the usual mechanism. A locked box suits a business whose balance sheet is reliable and stable, and a short gap between box date and completion. A business with volatile working capital or weak recent accounts is a harder fit.

DEFINED IN ONE PARAGRAPH → · COMPLETION ACCOUNTS → · NORMALISED WORKING CAPITAL →

For an acquisition lender, a locked box makes the amount to be funded certain at signing, apart from the value accrual, which grows if completion is delayed. That certainty is bought with a dated starting point. The credit paper's opening balance sheet is the box balance sheet, rolled forward on the buyer's estimate, and the lender reads three things: who prepared and checked the box accounts, how long the gap to completion is likely to run, and how the leakage promise is backed if the seller is a company that will distribute the proceeds. A short claim period with no money held back leaves the buyer, and so the bank, relying on the seller's goodwill.

EQUITY CONTRIBUTION → · MANDATORY PREPAYMENT →