U.S. private company deals typically have some sort of post-closing purchase price adjustment mechanism. In the U.K. and Asia, a “locked-box” approach is more common. A recent Cooley blog discusses how locked-box provisions work and some of the issues associated with them. This excerpt provides an overview:
The parties agree on a fixed price by referencing a set of agreed historical accounts – this is typically the last set of audited financial statements, but sometimes they’re unaudited management accounts or a set of accounts prepared specifically for these purposes –referred to as “locked-box accounts.” The locked-box accounts fix the equity price in respect of the cash, debt and working capital actually present in the target business at the date of the locked-box accounts, and determine the equity price that is written into the sale and purchase agreement (SPA).
From the date of the locked-box accounts, known as the “locked-box date,” the target company is essentially considered to be run for the benefit of the buyer – at least from a financial risk point of view – and no value, or “leakage,” is allowed to leave the business for the benefit of the seller. The box is therefore “locked.” Provided the box stays locked (more on this below), the SPA would not include any adjustment to the purchase price, and there would be no post-closing true-up. This is a key feature of the “locked-box” mechanism: The financial risk and benefit in the target pass to the buyer at the locked-box date.
The blog goes on to discuss the indemnity arrangements typically used to address any impermissible leakage that does occur and some of the arrangements that may be established to compensate the seller for running the business between signing and closing. The blog also addresses when a locked-box arrangement might make sense, as well as its advantages and disadvantages.
— John Jenkins, DealLawyers.com, Aug. 3, 2022