Purchase Price Mechanisms in M&A: Locked Box or Closing Accounts?

The purchase price in an M&A transaction is rarely just a fixed number written into the share purchase agreement. Several calculation steps often sit between the agreed enterprise value and the amount ultimately paid at closing.

This raises one of the key questions in many M&A transactions: How is the final purchase price determined?

Two purchase price mechanisms are particularly common:

• Locked Box
• Closing Accounts, also referred to as Completion Accounts

Both mechanisms are designed to determine the economic value transferred from seller to buyer.

Locked Box vs. Closing Accounts: the short answer

With a Locked Box, the purchase price is fixed by reference to a financial date before signing. The economic value of the business is therefore generally set before the purchase agreement is signed, and changes between the Locked Box Date and closing are mainly dealt with through Leakage provisions.

With Closing Accounts, also called Completion Accounts, the final purchase price is calculated from the actual financial position at closing. Cash, debt, Working Capital and other agreed items can still lead to a purchase price adjustment after signing.

Locked Box vs. Closing Accounts at a glance

Enterprise Value and Equity Value

Many purchase price discussions start with the Enterprise Value.

In simplified terms, this reflects the value of the operating business independently of its specific financing structure.

The amount ultimately payable to the shareholders is generally based on the Equity Value.

A simplified calculation may look as follows:

Enterprise Value
+ Cash
− Financial Debt
+/− other agreed adjustments
= Equity Value

Depending on the transaction, further items may be relevant, including working capital, shareholder loans, certain liabilities or provisions.

The purchase price mechanism determines when these items are measured and how changes up to closing are treated.

How cash, debt and other adjustments are defined is specific to each transaction. The formula matters less than the definitions of the individual items in the purchase agreement.

What is a Locked Box?

Under a Locked Box structure, the purchase price is determined by reference to a financial date prior to signing.

This date is known as the Locked Box Date.

The calculation is usually based on financial statements or other financial information relating to that date. The Equity Value is therefore determined before the SPA is signed.

Example:

The company has an Enterprise Value of EUR 5 million at the Locked Box Date.

At that date, it has:

• EUR 500,000 of cash
• EUR 300,000 of financial debt

The simplified Equity Value would be:

EUR 5,000,000
+ EUR 500,000 Cash
− EUR 300,000 Debt
= EUR 5,200,000 Equity Value

This amount forms the basis for the purchase price.

As a general rule, there is no subsequent purchase price adjustment based on closing accounts.

The economic concept behind a Locked Box

In a share deal, legal ownership of the shares transfers to the buyer at closing.

The economic risks and benefits of the business from the Locked Box Date are generally allocated to the buyer.

For this structure to work, value must not be extracted from the target for the benefit of the seller between the Locked Box Date and closing.

This is where Leakage becomes important.

A Locked Box therefore moves a large part of the purchase price discussion to the period before signing. Buyer and seller need to agree on the relevant financial information, the definition of Leakage and which value transfers are permitted.

What is Leakage?

Leakage refers to value transferred from the target to the seller or related parties between the Locked Box Date and closing.

Examples may include:

• dividends
• distributions
• repayment of shareholder loans
• certain management fees
• payments to affiliated companies
• transfers of assets

The seller will therefore usually undertake in the SPA that no prohibited Leakage has occurred or will occur.

If Leakage does occur, the seller will generally be required to reimburse the relevant amount.

What is Permitted Leakage?

Certain payments may be expressly agreed as Permitted Leakage.

Not every outflow of value between the Locked Box Date and closing has to be prohibited.

Depending on the transaction, this may include specifically agreed distributions, remuneration or other payments already known at signing. What matters is that their scope and treatment are clearly set out in the SPA.

Clear drafting is important.

The buyer should know at signing which payments may still be made before closing.

Advantages of a Locked Box

The main advantage is price certainty.

The purchase price is largely fixed at signing. Buyer and seller know at an early stage what amount is expected to be paid at closing.

The post-closing process is also simpler. There is generally no need to prepare detailed closing accounts followed by a purchase price adjustment.

This reduces post-closing work and limits the scope for later disputes over individual balance sheet items.

A Locked Box can also be attractive to sellers because the purchase price is generally not recalculated after closing on the basis of updated financial figures.

What buyers should consider in a Locked Box

The quality and currency of the financial information used for the Locked Box are particularly important for the buyer.

Where the Locked Box Date is several months before closing, the financial position of the business may change during that period.

Key considerations therefore include:

• reliable Locked Box Accounts
• Financial Due Diligence
• clear Leakage provisions
• buyer information rights
• covenants between signing and closing

The longer the period between the Locked Box Date and closing, the more important these protections become.

What are Closing Accounts?

Under a Closing Accounts mechanism, the final purchase price is determined by reference to the financial position of the target at closing.

A provisional purchase price is often agreed at signing.

Following closing, closing accounts or a similar calculation are prepared. These figures are then used to determine the final Equity Value.

Common adjustment items include:

• Cash
• Financial Debt
• Net Debt
• Working Capital
• other agreed purchase price adjustments

The provisional purchase price is then adjusted upwards or downwards.

How do Closing Accounts work in practice?

1. Provisional purchase price. At signing or closing, the parties often work with estimated figures.
2. Closing. The economically relevant date is reached.
3. Closing Accounts. After closing, the items defined in the purchase agreement are calculated from the actual financial figures.
4. Purchase price adjustment. The provisional price is adjusted in line with the agreed calculation mechanics.

Example of Closing Accounts

Assume that buyer and seller agree an Enterprise Value of EUR 5 million.

At signing, the estimated closing figures are:

• EUR 400,000 Cash
• EUR 300,000 Debt

The provisional Equity Value is therefore EUR 5.1 million.

After closing, the actual figures show EUR 300,000 of cash and EUR 350,000 of financial debt.

The final Equity Value is therefore lower.

Depending on the purchase agreement, the seller may be required to repay part of the amount initially received.

Working Capital adjustments

Closing Accounts often include more than Cash and Debt.

A Working Capital adjustment is meant to ensure, in economic terms, that the business is handed over with an agreed or normalised level of operating Working Capital.

For many operating businesses, Working Capital is a significant part of the purchase price calculation.

The buyer will usually want the business to be delivered at closing with an agreed or normalised level of Working Capital.

A target Working Capital amount is therefore often agreed.

If actual Working Capital at closing is below the target, the purchase price may be reduced.

If it is above the target, the purchase price may be increased.

The definition is critical. The purchase agreement should clearly state which receivables, liabilities and other items are included.

Which items are included in Working Capital and which target value applies has to be defined for the specific deal.

Where disputes often arise

Closing Accounts can become technically complex.

Discussions often focus on questions such as:

• What qualifies as Cash?
• What qualifies as Debt?
• Which items are already included in Working Capital?
• How are provisions treated?
• Which accounting principles apply?
• How are exceptional or unusual items dealt with?

For this reason, purchase agreements using Closing Accounts often contain detailed definitions and accounting rules.

They also commonly include a procedure for resolving disagreements. Specific accounting disputes may, for example, be referred to an independent accountant or expert.

Locked Box or Closing Accounts?

The appropriate structure depends on the transaction.

A Locked Box may be suitable where reliable financial information is available and the parties want a high degree of price certainty at signing.

Closing Accounts may be appropriate where material balance sheet items may still change before closing or where the parties want the final purchase price to reflect the financial position of the business at completion.

Relevant factors include:

Quality of financial information

The more reliable the figures at the Locked Box Date, the easier it is to implement a Locked Box structure.

Time between signing and closing

The longer this period, the more important the treatment of changes before closing becomes.

Working Capital volatility

Businesses with significant seasonal or operational fluctuations may be more suited to a Closing Accounts mechanism.

Deal dynamics

The competitive situation in a sale process may also influence the chosen mechanism.

Complexity

Complex balance sheets can make the Closing Accounts process more time consuming and increase the scope for post-closing discussions.

When a Locked Box may be the better fit

• reliable historical financial information
• a wish for high price certainty at signing
• limited expected changes up to closing
• Leakage provisions that can be clearly defined

When Closing Accounts may make more sense

• material changes in the financial position expected before closing
• strongly fluctuating Working Capital
• a longer period between signing and closing
• a wish to tie the final price closely to the actual position at closing

These are indicators, not rules. The specific transaction decides which mechanism fits.

Buyer and seller perspective

Buyer and seller interests in the purchase price mechanism are not automatically opposed, but they put the emphasis in different places.

Sellers often value price certainty and a clean economic exit. Buyers mainly want to make sure that the agreed economic position of the business is actually transferred.

Which mechanism favours which party cannot be answered in the abstract. It depends on the financial information, the business model, the negotiating position and the definitions in the purchase agreement.

Definitions in the purchase agreement matter

The labels “Locked Box” and “Closing Accounts” alone do not determine how the purchase price operates in practice.

The detailed definitions in the purchase agreement are critical.

For Closing Accounts, the key concepts often include:

• Cash
• Debt
• Working Capital
• Accounting Principles
• calculation methodology
• timelines
• dispute resolution procedures

For a Locked Box, key concepts usually include:

• Locked Box Accounts
• Leakage
• Permitted Leakage
• Leakage Period
• seller warranties or undertakings
• any agreed interest or value accrual

Small differences in these definitions can have a material impact on the final purchase price.

Should the purchase price mechanism already be addressed in the LOI?

The basic purchase price mechanics should be discussed early in the transaction.

A Letter of Intent can already specify:

• the agreed Enterprise Value
• whether a Locked Box or Closing Accounts mechanism is envisaged
• the relevant reference date
• whether Net Debt will be taken into account
• whether a Working Capital adjustment is intended
• the key assumptions underlying the valuation

Not every technical definition needs to be fully negotiated at LOI stage.

The parties should, however, have a common understanding of how the agreed Enterprise Value will translate into the amount ultimately payable to the seller.

For buyers acquiring a company for the first time, the purchase price mechanism is therefore one of the issues that should be considered early in the process. More information on the acquisition process is available on our page for Searchers and Entrepreneurs through Acquisition. What matters after an LOI is signed is covered in LOI signed: what searchers should not underestimate.

Purchase price mechanisms should reflect the economics of the deal

Purchase price clauses can quickly become technical.

The underlying commercial question is straightforward:

What economic value is the buyer acquiring and what amount should the seller receive for it?

The purchase price mechanism translates that commercial understanding into contractual rules.

Valuation, financial data and purchase agreement drafting therefore need to work together.

An unclear definition of Debt, an incorrect Working Capital mechanism or an overly broad Permitted Leakage provision can directly affect the amount ultimately paid. Findings from legal due diligence often feed directly into these definitions.

FAQ: purchase price mechanisms

What is a purchase price mechanism in M&A?

A purchase price mechanism sets out how the agreed enterprise value is turned into the price actually paid to the seller. Cash, debt, Working Capital and other agreed adjustments may be relevant.

What is the difference between a Locked Box and Closing Accounts?

With a Locked Box, the price is generally set by reference to a date before signing. With Closing Accounts, the final price is calculated from the financial position at closing.

What are Completion Accounts?

Completion Accounts is another name for Closing Accounts: a mechanism where the final purchase price is calculated from the financial position at completion.

What does Leakage mean in a Locked Box?

Leakage means value flowing out of the target to the seller or related parties between the Locked Box Date and closing, unless it has been agreed as Permitted Leakage.

How does Working Capital affect the purchase price?

Where a Working Capital adjustment is agreed, a deviation from the target value can increase or reduce the price. The exact effect depends on the calculation mechanics in the purchase agreement.

Should Locked Box or Closing Accounts already be agreed in the LOI?

The basic purchase price logic should be settled as early as possible. Detailed definitions are usually worked out in the purchase agreement.

Conclusion

Locked Box and Closing Accounts are the two key purchase price mechanisms used in M&A transactions.

Under a Locked Box, the purchase price is determined by reference to a date before signing. There is generally no post-closing purchase price adjustment. Leakage provisions are used to protect the buyer against value being extracted from the target between the Locked Box Date and closing.

Under a Closing Accounts mechanism, the final purchase price is determined by reference to the actual financial position of the business at closing. This allows the price to reflect the economics of the target at completion and requires an additional post-closing calculation and reconciliation process.

The appropriate structure depends on the business, the available financial information and the specific transaction.

If you want to understand what this kind of support costs, see How much does M&A advisory cost when buying a business?