Consideration Clause In Mergers And Acquisitions: Closing Accounts vs Locked Box

• Published date: 02 April 2024
• Subject Matter: Corporate/Commercial Law, M&A/Private Equity
• Law Firm: Kilinc Law & Consulting
• Author: Oğuzcan Dozcan and Elif Kalebek

OVERVIEW

In mergers and acquisitions, the determination of the purchase price and payment terms are among the key concerns of the parties to the transaction. In these transactions, we encounter full payment at a predetermined price on the closing day, similar to conventional sales agreements, as well as structures that are subject to installments, profitability targets or price adjustment mechanisms. The issue of consideration depends primarily on the agreement of the parties on commercial terms, however, the implementation of this clause, which can be quite technical, into the share purchase agreement require the intervention of legal and financial teams.

In this article, we will explain closing accounts and locked box, the two most common pricing mechanisms in mergers and acquisitions involving share transfers, and discuss the advantages and disadvantages of these systems.

A. TRADITIONAL METHOD: CLOSING ACCOUNTS

The "closing accounts" is the most commonly used mechanism in practice. Typically, the parties agree on an enterprise value, on a cash-free and debt-free basis, on the signing date of the share purchase agreement, taking into account market conditions and the outcomes of legal, financial and technical due diligence. The primary objective in determining the enterprise value is to calculate the purchase price based on this value, taking into account the net debt and working capital at the closing date.

However, as companies continue to operate, their financials are constantly changing and it is not possible to calculate the closing net debt and working capital, i.e. the closing accounts, precisely on the closing date. For that reason, the enterprise value is taken as fixed, and an estimated purchase price determined based on the net debt and working capital forecast for the closing date is paid by the buyer to the seller at the closing. This payment is commonly based on (i) the financials as of a certain date that is a date before the closing or (ii) as close as possible to the closing date, the good-faith estimate of the seller, who holds the company's financials until the closing, regarding the net debt and working capital, and therefore the purchase price; and is supported by representations and warranties provisions related to the accounts to protect the buyer.

Upon the completion of the closing, a retrospective examination is conducted on the company's financials, leading to the determination of the now available closing accounts. This allows...