What SME owners need to know about two of the most common ways to price a deal

If you are selling your business, one of the first structural decisions your buyer’s lawyers will raise, often before you have even agreed a price in principle, is whether the deal will be priced on a locked box basis or by reference to completion accounts. It sounds like a technical drafting point best left to the lawyers and accountants. In practice, it can materially affect what you actually walk away with, how much risk you carry after signing, and how smoothly (or painfully) the weeks after completion go.

This article explains what each mechanism means, how they differ in practice, and the questions sellers should be asking before agreeing to either.

The basic problem both mechanisms solve

In almost every SME sale, there is a gap between the date the heads of terms are agreed and the date the deal actually completes and money changes hands. During that gap, the business keeps trading: cash comes in, debts are paid, stock moves, and the balance sheet keeps changing.

The price for the business is normally based on a “cash-free, debt-free” valuation, adjusted for the actual level of cash, debt, and working capital in the business at completion. Both locked box and completion accounts are simply two different ways of pinning that adjustment down. They answer the same question in different ways: what was the financial position of the business on the day that matters, and how does that affect the price?

Locked box: fix the price now, based on a historic balance sheet

Under a locked box mechanism, the parties agree the price based on a balance sheet at a fixed date in the past, often the last set of management accounts or the most recent month-end, before contracts are signed,, sometimes specific locked box accounts will be prepared as part of the deal negotiations. From that date (the “locked box date”) to completion, the seller agrees not to extract any value from the business outside the ordinary course of trading. This is enforced through:

  • Leakage provisions in the SPA, restricting dividends, management fees, waived debts, and other value extraction between the locked box date and completion
  • Permitted leakage carve-outs for agreed items (normal salaries, routine intercompany payments)
  • An indemnity from the seller to repay the buyer, pound for pound, for any unpermitted leakage discovered after completion

Once signed, the price is fixed. There is no post-completion adjustment mechanism to argue about (subject to any leakage claims).

Completion accounts: fix the price later, based on the actual numbers on the day

Under a completion accounts mechanism, the price is provisionally agreed at signing, but is then adjusted after completion by reference to a set of accounts prepared as at the completion date itself. Typically:

  • The buyer (or sometimes the seller) prepares draft completion accounts within an agreed period after completion, calculating actual cash, debt, and working capital
  • The other party has a right to review and dispute the figures
  • If they cannot agree, the dispute is typically referred to an independent accountant for final determination
  • The purchase price is then adjusted up or down (a “true-up”) based on the final figures, sometimes months after the deal has completed

Where sellers get caught out

Regardless of which mechanism is used, we regularly see sellers come unstuck on the same handful of points:

  • Agreeing to a locked box without properly understanding what counts as “leakage.” A wide leakage definition, or a poorly negotiated permitted leakage list, can leave a seller unable to take normal payments (bonuses, dividends already declared, fees to connected parties) that they assumed were unaffected.
  • Underestimating how long completion accounts disputes can run. A disagreement over stock valuation, bad debt provisions, or accrual treatment can leave part of the price outstanding, and the relationship with the buyer strained, for months after completion.
  • Not engaging their own accountants early enough. Whichever mechanism is used, the accounting definitions in the SPA (what counts as debt, what counts as normalised working capital) drive the actual amount you receive. These are legal drafting points with real financial consequences, and are worth as much scrutiny as the headline price.
  • Assuming the mechanism is set in stone. Both structures are negotiable, and hybrid approaches exist. It is worth asking the question rather than accepting the buyer’s first proposal as the only option.

The questions to ask before you agree

  • If locked box: what exactly is included in the leakage definition, and does the permitted leakage list cover everything I need it to?
  • If completion accounts: how is working capital defined, and does that definition reflect how this business actually operates day to day?
  • Who is preparing the completion accounts, and on what timetable?
  • What happens if we cannot agree the figures, and who bears the cost of an independent accountant if it comes to that?
  • How long is the expected gap between signing and completion, and does that change which mechanism makes more sense?

Our approach                                                             

Getting the pricing mechanism right is one of the most commercially significant, and most frequently under-negotiated, parts of an SME sale. We work closely with your accountants from an early stage to make sure the mechanism chosen, and the definitions that sit behind it, actually reflect the deal you think you are doing.

Please contact our Corporate and Commercial Solicitor James Bowles to discuss how we can help at james.bowles@wellerslawgroup.com.