Locked Box
Under a locked box mechanism the purchase price is fixed on the basis of an already audited balance sheet at a date before signing, and is not adjusted afterwards. The seller bears the business risk up to that date, the buyer from it. The contract protects this through a ban on value outflows, known as leakage.
Locked box and closing accounts are the two usual routes from a negotiated enterprise value to a price actually paid. Under a locked box the parties fix a date in the past – normally the last audited or near-audited accounts – and calculate the price on that balance sheet. Nothing is adjusted afterwards.
Why a mechanism is needed at all
What is negotiated is usually enterprise value, the value of the operating business. What is paid is equity value, the value of the shares. Between the two sit net debt and working capital. The only question is the date on which both are measured. A locked box measures at the locked box date; closing accounts measure at completion.
Leakage and permitted leakage
Because the business economically belongs to the buyer from the locked box date, the contract has to prevent value flowing out to the seller in the meantime. Such outflows are called leakage: distributions, bonuses to shareholders, advisory fees to related parties, waivers of receivables. They are deducted from the price, as a rule euro for euro and without a liability cap. What remains expressly allowed – contractually agreed management remuneration, or ongoing rent to a shareholder – is listed individually as permitted leakage.
Value accrual: interest on the wait
Between the locked box date and completion the business keeps generating earnings that economically belong to the buyer. The seller is frequently compensated for this, either through a fixed daily amount on the price or a percentage rate. Where completion is delayed, for instance by merger control, this item is not a side issue.
When a locked box fits
- audited or near-audited accounts exist that both sides trust
- the period to completion is manageable
- the seller wants price certainty and no argument over a completion balance sheet
In European auction processes run by private equity houses the locked box is the norm, because it makes bids comparable: every bidder calculates on the same balance sheet. In a carve-out, on a weak data basis, or with volatile working capital the mechanism is risky – closing accounts are then the cleaner route.
What the finance function has to contribute
The locked box accounts are the basis of the price. They must be fully accrued, the net debt items defined and evidenced, and every payment to shareholders between the locked box date and completion documented and tested against the leakage definition. Anyone assembling that only after signature is negotiating about deductions rather than about numbers.