Locked Box vs Completion Accounts: How the Final Price Gets Set

Most acquisitions are priced on a cash-free, debt-free basis with a normal level of working capital. The buyer agrees an enterprise value. The equity price, what is actually paid for the shares, is that enterprise value plus cash, minus debt and debt-like items, plus or minus any difference between actual and normal working capital. Our guide to enterprise value vs equity value walks through the bridge.

The difficulty is timing. Cash, debt and working capital are different on every day between the letter of intent and completion. Someone has to decide which day's balance sheet sets the price, and who keeps the profit, or bears the loss, generated in between. That is the job of the price mechanism.

In a locked box deal the parties choose a locked box date, usually the date of the most recent audited or reviewed balance sheet. The equity price is calculated from that balance sheet and written into the purchase agreement as a fixed number. There is no adjustment after completion.

From the locked box date, economic risk and reward pass to the buyer, even though the seller still owns and runs the company until completion. To stop the seller extracting value in that window, the seller promises there has been, and will be, no leakage: no dividends, management fees, bonuses, asset transfers, waived debts or other payments to the seller or its connected parties, except for permitted leakage listed and quantified in the agreement. Leakage is usually repaid pound-for-pound or dollar-for-dollar.

• Locked box dateThe balance sheet date the price is based on. The older it is, the more the buyer relies on how the business has performed since.
• LeakageAny value passing from the target to the seller side after the locked box date. Defined broadly, listed precisely.
• Permitted leakageAgreed exceptions, such as normal salaries to seller-employees, each named and capped.
• Ticker or interestA daily amount sometimes added to the price to compensate the seller for profits generated after the locked box date. Often linked to cash generation.
• Conduct of businessUndertakings that the seller runs the business normally between signing and completion.

Under completion accounts the buyer pays an estimated equity price at completion, using the seller's estimate of cash, debt and working capital at that date. After completion, one party, often the buyer because it now controls the books, prepares completion accounts as at the completion date using agreed accounting policies. The other party reviews them. The price is then adjusted for the difference between estimated and actual figures.

1. 01Preparation periodCommonly 60 to 90 days after completion for the draft accounts.
2. 02Review periodThe other side checks them and raises objections within a set window.
3. 03Dispute resolutionUnresolved items go to an independent accountant acting as expert, whose decision is usually binding on those items.
4. 04SettlementThe paying party settles the adjustment, sometimes from an adjustment escrow set up at completion.

The working-capital peg

The peg (or target) is the normal level of working capital the buyer expects to receive, usually based on a trailing average to smooth out seasonality. If actual working capital at completion is above the peg, the price goes up; below it, the price goes down. Setting the peg well matters more than almost any other term in a completion accounts deal. The NWC peg calculator shows how averages and seasonality change the number.

A buyer agrees an enterprise value of $30 million for a software company. Normal working capital (the peg) is $1.0 million. The figures below are hypothetical.

In the locked box column the seller receives $29.2 million, plus any agreed ticker, and keeps nothing generated after 31 March except through that ticker. In the completion accounts column the buyer pays $29.9 million at completion and, after the accounts are agreed, the seller repays $0.6 million because cash and working capital came in below the estimate. Same business, different timing, different risks.

• Quality of accountsRecent audited or reviewed accounts favour locked box. Unaudited or complex books favour completion accounts.
• VolatilityIf working capital swings with seasons or large contracts, completion accounts protect both sides better.
• Carve-outsA business separated from a group rarely has standalone historic accounts, which pushes towards completion accounts.
• Seller prioritiesSellers wanting certainty and a quick distribution usually push for locked box.
• Buyer prioritiesBuyers short on diligence time or wary of the accounts usually prefer completion accounts.

Terms to watch

• In locked box deals: breadth of the leakage definition, the permitted leakage list, the claim period, and any ticker
• In completion accounts deals: the accounting policy hierarchy, the peg methodology, de minimis thresholds, the adjustment escrow and the expert process
• In both: what counts as debt and debt-like items, how cash is defined (trapped cash, customer deposits), and how earnouts or deferred payments interact with the price

Related reading: M&A transaction costs explains why adjustments are price, not cost; W&I insurance vs escrow covers how warranty claims are funded; the earnout modelling tool models contingent price. Our LOI teardowns show where the mechanism should first appear.