How prevalent is the use of locked box pricing mechanisms in your jurisdiction and in what circumstances are these ordinarily seen?

Private Equity (2nd edition)

Greece Small Flag Greece

Locked box mechanism is gaining ground in M&A transactions in Greece, mainly due to the complexity of negotiations in relation to the closing price adjustment calculations. That being said, it is not yet the prevailing mechanism, since parties are still more familiar with the ‘more traditional’ closing accounts mechanism. This has also led to circumstances where, although typically locked box was used, in reality ‘leakage’ and ‘permitted leakage’ elements were formed in such way that resembled the closing accounts calculations (i.e. debt, debt-like items etc). Locked box mechanism will be typically used in circumstances where: (a) there is not a big time gap between singing and closing; or (b) there is a private auction sale process whereby the seller: (i) intends to receive and compare clear bids without having to take into account the various closing mechanics; and/or (ii) is not willing to enter into complex parallel negotiations, in relation to closing adjustment, with more than one party; or (c) the target’s business is not unpredictable.

Luxembourg Small Flag Luxembourg

Locked box is the most common and ordinarily used pricing mechanism.

Locked box pricing mechanisms are more typically seen when parties are looking to minimise post transaction adjustments to consideration as would occur with closing accounts pricing mechanism.

The Netherlands Small Flag The Netherlands

In the Netherlands, locked box pricing mechanisms are used in the far majority of transactions. An internal sample study showed a percentage of approximately 60% of the transactions containing a locked box mechanism in 2018.

The locked box approach is the favoured approach of selling financial sponsors, allowing a clean exit and providing the possibility to distribute the consideration more quickly. The absence of any post-completion adjustment eliminates the need to hold back funds in case adjustment works against the seller.

It may be problematic for a buyer to agree to a locked-box mechanism where the target is carved-out from a larger group, since it is easier for the seller to manipulate leakage from the target, for example, by hedging agreements, allocation of group overheads, current accounts and intra-group trading. Generally, however, if carefully drafted, the indemnity for leakage should provide for an adequate remedy.

Norway Small Flag Norway

According to our surveys, locked box pricing mechanism is used in approximately 50% of the transactions in the Norwegian market, with some variations from year to year. Such variations may be caused by market conditions and the mix of transactions executed by financial sponsors and industrial players. The locked box approach is generally preferred by financial sponsors, while industrial players are often more comfortable with using completion accounts. In controlled auction processes, a locked box approach would normally be preferred unless there are strong arguments for using completion accounts.

Poland Small Flag Poland

They are available and familiar to parties but not used in every deal. We observe this purchase price mechanism in deals where the value of businesses subjected to transactions does not change rapidly.

South Korea Small Flag South Korea

Use of locked box pricing mechanisms is not very common in Korea, and is used sparingly (generally in cross boarder auction deals or deals involving very attractive targets).

Sweden Small Flag Sweden

Locked box pricing mechanisms are commonly used in Sweden. In our experience, the last few years, locked box mechanisms were chosen in approximately 50% of all the transactions and in 2018 the number increased significantly to 70%. Locked box mechanisms are still more predominant but during recent years (prior to 2018) the use of other purchase price adjustment mechanisms (i.e. closing balance sheet mechanisms and other forms of true-ups) have increased again, and on average, the last few years have been on par with the locked box structure. We believe the increased use of purchase price adjustment mechanisms is partly due to the increased number of carve-outs on the Swedish market lately. However, locked box pricing mechanisms are still particularly favoured by financial sponsors. In transactions where there is a financial sponsor on the sell-side, the locked box pricing mechanism is chosen in approximately 80% of the transactions, in 2018 the number was even higher at 90%.

Switzerland Small Flag Switzerland

Contrary to the USA and Asia, locked box pricing mechanisms are widely used in Switzerland. In particular in the still prevailing sellers' market, sellers seeking to limit balance sheet risks and reduce the risk of post-closing purchase price adjustment disputes will push towards using locked box pricing mechanisms.

Due to the current sellers' market, locked box pricing mechanisms are often combined with an interest payment or cash flow participation, respectively, since the locked box date allowing sellers to participate in the cash flow generated in the period between the locked box date and actual payment of the purchase price (i.e. consummation of the transaction) and buyers tend to accept longer periods between the locked box accounts and closing.

Belgium Small Flag Belgium

In Belgium, locked box pricing mechanisms are used in almost half of the transactions. They are especially prevalent in transactions with a deal value of more than EUR 100 million.

The locked box approach is the favoured approach of selling financial sponsors, allowing a clean exit and providing the possibility to distribute the consideration more quickly. The absence of any post-completion adjustment eliminates the need to hold back funds in case adjustment works against the seller.

It may be problematic for a buyer to agree to a locked-box mechanism where the target is carved-out from a larger group, since it is easier for the seller to manipulate leakage from the target, for example, by hedging agreements, allocation of group overheads, current accounts and intra-group trading. Generally, however, if carefully drafted, the indemnity for leakage should provide for an adequate remedy.

Canada Small Flag Canada

Locked box mechanisms are very uncommon in Canadian transactions.

China Small Flag China

The two commonly used pricing mechanisms in M&A (and private equity) deals in China are locked box approach and completion accounts approach. When applying the locked box approach, the purchase price agreed upon by both parties is a fixed price. On the other hand, in the completion accounts approach, the purchase price will be adjusted after the closing in accordance with the financial statement of the target company immediately prior to the closing. Currently, they are both widely used in China.

Generally speaking, the locked box approach is more preferred by the sellers because the purchasers have to rely on the financial statements prepared by the sellers as of the dates mutually agreed upon by both parties prior to the signing to determine the enterprise value of the target companies. After signing the agreement, the risk of the value decrease of the target companies prior to the closing is borne by the purchasers. Therefore, the purchasers will usually want very strict representations and warranties and covenants with respect to the operation and financial conditions of the target companies between the financial statement date and date of closing. Moreover, it is also less complex than the completion accounts approach and involves less transaction costs. Hence, comparatively speaking, locked box approach is more ordinarily seen in seller’s market where the sellers usually have more negotiating leverage than the purchasers (for example, when the sale is conducted through an auction and the seller can receive bids from various purchasers) and/or small transactions where both parties want to keep the transaction process simple.

France Small Flag France

Almost all transactions involving financial sponsors are now based on a locked box mechanism. On the other hand, closing/adjustment accounts are still used in trade sales although the use of locked box mechanism is more and more frequent.

In certain – and rare – instances, hybrid mechanisms could be put in place. In those instances, the price is based on a set of historical accounts and there is a covenant that a certain amount of net debt or working capital is not exceeded at closing. This would be typically the case when revenues of the target group are highly seasonal and the cash flow forecast may not be relied upon.

Germany Small Flag Germany

Currently, the locked-box structure is the most common pricing structure in the German M&A market. A key benefit and reason it is preferred by financial sponsor sellers is certainty of price at the time of signing. A locked-box structure is also widely used by strategic sellers as it is far less complex and bids received in the auction process are easier to compare. The structure assists to avoid disputes regarding the final price adjustment as it provides the necessary data regarding the adjustment items in the relevant financial statements. In case of an adjustment, sellers tend to seek interest on the purchase price, however, no interest is actually charged for leakage of value to the seller as it is treated as a purchase price reduction.

Mexico Small Flag Mexico

There is no general rule in México with respect to pricing mechanisms, that said, traditional pricing mechanisms to closing accounts are seen more often than “locked box” mechanisms.

United Kingdom Small Flag United Kingdom

The ‘locked box’ mechanism is the most common pricing structure on UK private equity deals. The key advantage of the locked box is that it gives both the seller and the buyer certainty of a fixed price and does not give rise to the same complexity and risk of associated disputes as the completion accounts mechanism. However, certain deals may not be suited for locked box mechanisms, for example (i) if the transaction involves a business reorganisation or carve-out following the locked box date and therefore the target does not have appropriate standalone accounts and (ii) if the target’s working capital is subject to high degrees of volatility (e.g. open to the effects of seasonality) and therefore it is difficult to price based on a fixed historic date.

Vietnam Small Flag Vietnam

Locked box pricing structures are the most common pricing structure for small-sized or less complex transactions that do not include any pre-deal restructuring of the target business. The buyer assumes the economic risk of the target’s business performance as from the locked box date and, therefore, prior to the signing of the share purchase agreement. The share purchase agreement usually restricts leakage as from the locked box date up to and until the closing date (except for any permitted leakage that has been expressly agreed upon).

Post-closing price adjustments based on the target’s financial statements as at the closing date (i.e., completion accounts) are increasingly common for large or complex transactions (that may or may not include pre-deal restructuring of the target’s business). The parties will agree on methods and principles of calculation in order to determine the valuation of the target company, though this is typically achieved by use of net asset value and/or earnings. It is customary for the valuation to be finally determined by an independent expert jointly appointed by the parties.

India Small Flag India

While this could be heavily negotiated, post-closing holdbacks/cash adjustments with respect to foreign buyers and investors are not very popular in India and could also involve regulatory hurdles in case the deal is subject to the requirements of the foreign exchange laws in India, which restricts the commercial freedom of such parties. However, such a mechanism, due to the vastly reduced set of conditions and compliances, is fairly common amongst Indian domestic parties. This has already been dealt with in Question 2 of this section and applies to any primary investment or secondary transfer in a company. This also applies in the event that a non-resident buyer (i) agrees to purchase 100% and defers payment of, say, 25% from it for a later date; and (ii) makes payment for a lesser amount, say, for 80% at the first instance, and thereafter, makes payment of the remaining 15% via a separate transaction altogether, with no deferred or tranched payments. Therefore, non-resident financial sponsors and investors prefer the locked box pricing mechanism because it offers them a pre-agreed, definite and fixed price for a clean exit, without having to comply with foreign exchange pricing guidelines every time that a payment is made. A fixed price ensures return of capital to the limited partners of such financial sponsors during their fund life and provides comfort to them, given that they no longer have to bear the risk of any requirements to adjust such amounts at a later date.

Despite the general preference of financial sponsors to use the locked box pricing mechanism, there may be situations in which certain issues are negotiated towards specific indemnity holdbacks, escrow arrangements and/or for adjustments, subject to the deferred payment mechanism and conditions set out under the foreign exchange rules in India, and dealt with in Question 2 above. Such adjustments/holdbacks are mostly agreed in relation to known or contingent accounting liabilities, tax risks, litigation or liability with respect to regulatory non-compliances, among other things. However, in such cases, it is agreed between the parties that the risk of foreign exchange fluctuations and potential non-compliance with pricing guidelines will be borne by the non-resident buyer.

Ireland Small Flag Ireland

While several years ago a locked box mechanism was not very common, it is now used on virtually all auction deals and PE exits as it offers certainty in the purchase price from the outset, greater control over financial information, fixing the date of economic transfer of the target before completion and prompt distribution of sale proceeds to sellers after completion. A locked box mechanism is used less often on acquisitions from founders or complex carve-out transactions.

Finland Small Flag Finland

Hannes Snellman: Locked-box mechanisms are common in auctions and are particularly prevalent in transactions involving financial sponsor sellers, who generally prefer certainty concerning the purchase price and ability to distribute the purchase price promptly to their investors. Moreover, an interest component calculated from the locked-box date is commonly used and typically negotiated on case-by-case basis depending on the business under acquisition. Buyers, in such situations, spend significant time and resources on thorough due diligence, modelling and valuation in order to accurately assess the purchase price and likelihood of leakage etc.

Brazil Small Flag Brazil

Although locked-box pricing mechanisms are becoming more common in Brazil, closing accounts mechanisms still prevail in private acquisition or disposal of equity interests and assets. We may perceive the use of locked box pricing mechanisms in Brazil in cases which the parties have an amicable and trustful relation, setting a comfortable scenario for the parties to rely on the financial statements given by a financial detailed audit. Another circumstance to assume locked box pricing mechanisms is a conjecture of costs avoidance with a fast pace to conclude the transaction.

Austria Small Flag Austria

In Austria, locked box pricing mechanisms are more frequently seen than closing accounts. Private equity investors tend to prefer locked box structures, particularly when they are on the sell-side. Likewise, experienced trade sellers usually prefer locked box structures. Where the gap between signing and the anticipated date of closing is long (e.g. because of antitrust or other clearance requirements), closing adjustments are the norm. Which parameters are included in a closing adjustment depends on the target business, with the most common combination being adjustments for net debt, working capital, and (sometimes) capex. Equity adjustments are relatively rare.

United States Small Flag United States

Although locked box transactions are used in a small minority of transactions in the US, we have seen an increase in their use within the last 12 months, especially in transactions with European buyers of US targets.

Japan Small Flag Japan

A locked box pricing mechanism (in which the seller and the buyer agree on a fixed purchase price as of a historical locked box date with special indemnification by the seller for any subsequent value leakage from the target after the locked box date and accrual of interests on the purchase price from the locked box date until the closing) is rarely seen in transactions in which the targets are Japanese companies.

There are a number of transactions in which the target is a Japanese company and in which the purchase price is agreed as a fixed amount and is not subject to any closing adjustment. However, they do not include provisions for leakage indemnification or interest accrual on the purchase price. In such transactions, negative covenants of the seller would usually be provided in the transaction documents to protect the buyer from any decrease of enterprise value of the target; and such negative covenants would typically include prohibitions on the seller from paying any dividend or effecting any material “leakage” from the target.

Updated: January 16, 2020