When a party buys the shares of a company, the transaction will often be referred to as:
- an accounts date deal;
- a completion accounts deal; or
- a locked-box deal.
All three names refer to the way in which the parties determine or adjust the price for the target company and impact on the way in which the buyer of the target company is protected from tax liabilities in the tax covenant. In almost all cases, the parties will agree a headline value for the shares being acquired, which is then adjusted by agreed mechanisms.
In an accounts date deal, the buyer determines the purchase price by reference to the previous set of year end accounts (and any information available by means of due diligence) and there will be no mechanism for adjustment of the purchase price within the share purchase agreement (other than by means of indemnity, warranty or tax covenant claims).
An accounts date deal is fairly uncommon because it provides no protection (other than specific protections under the tax covenant) for the buyer in respect of the trade of the target company (or its group) after the accounts date.
In a completion accounts deal, the purchase price will be adjusted by reference to a set of accounts prepared as at the date of completion and is perhaps the most precise way of reaching the intended purchase price.
In the share purchase agreement the parties will agree:
- what will be included in the completion accounts, e.g. whether it will be a full set of accounts, only a balance sheet or only a profit and loss account;
- which accounting policies should be used;
- the time frame for production of the completion accounts;
- who is responsible for the preparation of the completion accounts in the first instance;
- what rights the other party has to comment on or adjust the completion accounts; and
- a dispute resolution procedure.
A completion accounts deal has advantages for the buyer because it provides greater accuracy and fewer opportunities for surprises once the completion accounts are agreed and because legal and effective economic ownership transfer at the same time.
There are disadvantages of completion account deals however in that they can be complex and may require negotiation or resolution after completion; they can be time-consuming and expensive and divert the attention of management after completion; and they leave an element of uncertainty as to the purchase price until after completion.
A locked-box deal is essentially a hybrid between an accounts date deal and a completion accounts deal in that:
- the buyer will determine the purchase price by reference to a set of accounts, commonly a more recent set than the last year end accounts, the date of such accounts being the locked-box date (also known as the effective date), and any other information available by means of due diligence,
- the locked-box date is the date from which the buyer is treated as having taken economic ownership of the target company (or its group);
- the price is fixed at signing; and
- there is an additional covenant providing the buyer with pound for pound compensation for certain matters taking place between the locked-box date and completion (the anti-leakage provisions).
A locked-box deal is often considered to be a reasonable half way point between the positions of a buyer (who will want as much economic protection to run to completion as possible) and the seller (who will want the purchase price to be known prior to completion).
Whilst this can be a reasonable half way point, it’s worth noting that:
- the seller does not get the full benefit from continued operation of the target company in the interim period;
- the buyer places increasing reliance on warranties and comfort on the balance sheet, and may wish to carry out enhanced due diligence;
- there is a risk to the buyer that the trade of the target company may deteriorate between the locked-box date and completion; and
- the buyer will need to debate items such as debt and working capital earlier, with potentially less detailed knowledge.
Each of the price adjustment mechanisms provide advantages to a party, whether that is to the seller with knowledge of the purchase price at the commencement of negotiations by the use of the accounts date mechanism, or to the buyer with certainty that it is purchasing the business and assets or shares for the most accurate price at completion by the use of completion accounts, or by the parties adopting a hybrid locked-box mechanism. The chosen mechanism will largely depend on the bargaining position of the parties and their intended deal outcome.