Business Acquisitions: Purchase Price Mechanisms

Business Acquisitions: Purchase Price Mechanisms

In acquisitions, the choice of purchase price mechanism is a crucial factor that determines how the final payment is structured. Two of the most common approaches are the locked box mechanism (fixed price) and completion accounts (preliminary price with later adjustment). Each has its advantages, drawbacks, and implications for both buyer and seller.

Locked Box Mechanism

The locked box mechanism, widely used in Europe, sets the purchase price based on a historical balance sheet date agreed by the parties. This provides clarity and avoids post-closing adjustments.

Key components:

• Locked box date – A historical date on which the target’s financial position is determined and documented in a locked box balance sheet.
• Initial purchase price – The agreed price based on the financial position at the locked box date.
• Interest (ticking fee) – Sometimes applied to compensate the seller for the target’s cash flow generated between the locked box date and closing. The level is negotiated between the parties.
• Leakage provisions – Certain transactions (e.g., dividends, excessive bonuses, or non-arm’s-length payments to the seller) are prohibited. If they occur, they reduce the purchase price. Permitted leakage typically covers ordinary business expenses.

Advantages:

• Predictability – The purchase price is fixed in advance, reducing uncertainty.
• Simplicity – No post-closing adjustments or reconciliations.
• Time savings – Faster and less administratively burdensome.

Disadvantages:

• Buyer risk – The buyer bears the risk of financial changes between the locked box date and closing.
• Heavy reliance on due diligence – Accuracy of the locked box balance sheet is critical, as there is no later adjustment.

Completion Accounts

The completion accounts mechanism adjusts the purchase price after closing to reflect the target’s actual financial position at the transfer date.

How it works:

1. Preliminary price – At closing, the buyer pays a preliminary purchase price based on estimated figures.
2. Preparation of completion accounts – After closing, a final balance sheet is prepared, showing the company’s actual financial position at transfer.
3. Review and approval – Both parties review and agree on the completion accounts, resolving any disputes.
4. Final settlement – The purchase price is adjusted up or down based on the difference between the preliminary figures and the completion accounts.

Advantages:

• Reflects reality – The price is based on the actual financial position at closing.
• Fairness – Reduces the risk of either party overpaying or underpaying.

Disadvantages:

• Complexity – Requires detailed accounts, reviews, and sometimes lengthy negotiations.
• Potential for disputes – Disagreement over accounting treatments can delay settlement.

Choosing the right mechanism

The locked box offers simplicity and predictability, while completion accounts provide flexibility and accuracy. The choice depends on deal size, risk appetite, and the level of trust between buyer and seller.

By understanding the strengths and weaknesses of each approach, both parties can agree on a mechanism that supports a smooth, fair transaction.

At FLB Partners, we support clients throughout the M&A process — from valuation and negotiation to purchase price mechanisms and integration. Contact us today to learn how we can help structure your next acquisition for success.