Pricing mechanisms in M&A practice: the locked box

Two methods are often used to determine the purchase price of a company: the locked box and the closing accounts. In this article, I will focus specifically on the locked box method. What does this pricing mechanism entail, when is it appropriate, and what should you pay attention to as a buyer or seller?

What is a locked box?

The locked box method works with a fixed purchase price based on a historical balance sheet date (the “Locked Box Date”). This Locked Box Date is often set at January 1, because the previous financial year ends on December 31 for many companies. From the Locked Box Date, the buyer bears the economic risk, but also benefits from any potential returns.

The legal transfer of the shares only takes place at closing. This is done by means of a deed of transfer executed by a notary. The closing is therefore the date on which the notary signs the deed of transfer. The buyer therefore only becomes the legal owner of the shares (and thus of the company) at closing. However, because economic ownership shifts on the Locked Box Date, the price is determined on the basis of that older balance sheet. In principle, no further price adjustments are made at closing.

Leakage provisions: protection of the buyer

To prevent the seller from extracting value from the company between the Locked Box Date and the actual transfer, so-called leakage provisions are used. These provisions are laid down in detail in the purchase agreement and specify which payments or distributions (to the seller) are prohibited, unless expressly permitted. Examples include dividend payments, management fees, or loans to shareholders.

If it subsequently transpires that unauthorized expenses have been incurred, the buyer can claim the relevant amount from the seller. These leakage provisions therefore protect the buyer against any deviations.

Advantages for the seller

An important advantage for the seller is the degree of certainty offered by the locked box structure. Because the purchase price is already fixed on the basis of an earlier balance sheet date, the seller knows exactly how much he will receive. There is no need for (complicated) settlements or adjustments at the time of transfer. This usually means that the purchase price can also be paid immediately on the closing date. Furthermore, there is less room for discussion afterwards, for example about the interpretation of balance sheet items or the valuation of specific assets or liabilities. This predictability makes the locked box method attractive, especially in situations where speed and peace of mind are desired.

Advantages for the buyer

A locked box structure can also offer advantages for the buyer. The buyer is given access to the relevant figures in advance and can verify this information during the due diligence investigation. If the financial reporting is transparent and the business model stable, the buyer can use the historical balance sheet to estimate a reasonable price.

In addition, the buyer saves time and money because there is no need for complex settlements afterwards. In practice, the locked box method is often reinforced with additional guarantees regarding the accuracy of the figures as of the Locked Box Date.

At the same time, the buyer must realize that this system leaves less room for correction afterwards. It is therefore crucial that the due diligence investigation is carried out carefully.

Example

Suppose a family business with stable profitability over the past five years is sold to a buyer. The parties decide to set the Locked Box Date at January 1, 2025. The buyer conducts due diligence in March 2025, after which the purchase agreement is signed in May 2025. The legal transfer of the shares takes place on June 1, 2025.

Because the purchase price is based on the balance sheet as of January 1, 2025, and clear agreements have been made about prohibited expenditures in the intervening period, there is no discussion about the price at closing. The full purchase price can be transferred on the day of delivery. Any dividend payments or other payments to shareholders made between January 1, 2025, and June 1, 2025, would be contrary to the leakage provisions and would result in a repayment obligation.

Finally

The locked box method offers speed, clarity, and simplicity. The prerequisite is that the figures are accurate and the agreements have been carefully recorded. For the seller, it is an attractive route to a quick and secure exit. For the buyer, it requires thorough preparation and critical analysis of the figures.

Are you considering structuring an acquisition with a locked box? Our lawyers will be happy to advise you on the right approach, risks, and alternatives. Feel free to contact us by email, phone or fill out the contact form for a no-obligation initial consultation.