An M&A transaction, although perceived differently from the perspective of an investor planning to buy a company and  an entrepreneur selling his life’s work is always a multi-stage and complex process. Legal issues are inextricably linked to business and tax issues in this process. Moreover, it is not uncommonto manage not only the substantive aspects of the transaction but also the emotions, fears and hopes of its participants.

One of the most sensitive areas for transactions is price determination. Although the parties agree on a specific amount, a spread or a price calculation mechanism as early as at the term-sheet stage, it is usually also necessary to determine the method of calculating the final price, taking into account the actual condition of the business on the date of transaction closing. In extreme cases, the final price may significantly differ from the price specified in the term-sheet. Therefore, the share or stock sale agreements provide for methods of determining the price that allow for its final determination on a given date. The two basic methods are the so-called "Completion accounts" and "locked box".

Completion accounts

According to the "completion accounts" method, the agreed price is adjusted based on such financial items as net debt or change in the working capital of the target as at the closing date, most often based on estimated financial values. Subsequently, the final financial data is prepared, audited if necessary, and the agreed price is verified and adjusted.

Locked box

In the locked box model, the price is adjusted based on known financial data on an agreed day before the transaction. This mechanism essentially minimizes the parties' uncertainty as to the size of the adjustments, so the final price is known and fixed (subject to the so-called "cash flow compensation", i.e., periodical increase of the price by a certain amount to reflect the increase in the value of the acquired company, which is especially applicable in situations where more time elapses between the signing and the closing). When determining the price in the "locked box" model, it is particularly important from the buyer's point of view to provide for appropriate restrictions on the allowable outflow of funds from the company (the so-called leakage), e.g., dividend payment.

Which method to choose?

Although none of the methods is objectively better, our observations show that the "locked box" method has become more popular recently. Both methods require the introduction of appropriate clauses in agreements that will protect the seller against excessive "depletion" of the price, and the buyer against its unexpected increase. Moreover, for the security of the parties to the transaction, it is important that this complicated matter be formulated in a precise and clear manner.