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Share Purchase Agreement Pricing Mechanisms

We have seen a continued increase in energy transactions in the last year. Transactions typically include the use of either the ‘locked box mechanism’ or ‘completion accounts mechanism’, both of which are commonly used pricing mechanisms. Our Corporate team reviews the key features of both approaches and the distinct advantages they offer.


What you need to know

  • The ‘locked box mechanism’ and the ‘completion accounts mechanism’ are pricing mechanisms that are frequently used in Irish M&A transactions.
  • Under the ‘locked box mechanism’, the seller and buyer agree the purchase price payable for the acquisition of the shares in the target company by reference to a set of ‘locked box accounts’ before the SPA is signed.
  • Under the ‘completion accounts mechanism’, the seller and buyer agree the purchase price payable for the acquisition of the shares in the target company based on a set of ‘estimated completion accounts’. The preliminary purchase price is then adjusted following completion of the transaction based on a set of ‘completion accounts’ agreed by the parties. The ‘completion accounts’ can be settled/determined by an expert if there is any dispute between the parties when agreeing the ‘completion accounts’. It is worth noting that under a ‘locked box mechanism’ there is no post-completion adjustment of the purchase price.
  • The decision as to which pricing mechanism should ultimately be used will generally depend on the nature of the transaction and the bargaining power of the buyer and the seller.

The ‘locked box mechanism’ and ‘completion accounts mechanism’ are pricing mechanisms that are frequently used in Irish M&A transactions.

Locked box

Under the ‘locked box mechanism’, the seller and buyer agree the purchase price payable for the acquisition of the shares in the target company before the share purchase agreement (SPA) is signed and completed. This purchase price calculation is based on a set of ‘locked box accounts’. The ‘locked box accounts’ are financial statements prepared as of an agreed date during the target company's financial year, known as the ‘locked box date’, and must be accurate as of that date. The ‘locked box accounts’ can typically be audited year-end financial statements, recently available management accounts, or a balance sheet specifically prepared to another reference date during the financial year.

The ‘locked box mechanism’ excludes the possibility for a ‘post-completion price adjustment’ as the Purchase Price will ultimately be informed by the buyer’s reliance on the financial information in the Locked Box Accounts.

Leakage and permitted leakage

Under a ‘locked box mechanism’, the buyer assumes the risk of any potential 'leakage of value' from the target company between the ‘locked box date’ and the completion of the transaction, while the seller retains full control of the company. To protect the buyer against this, the buyer would ordinarily require the seller to give certain undertakings to guard against ‘leakage’ occurring between the ‘locked box date’ and the date of completion. Some examples of ‘leakage’ can typically include the payment of dividends or distributions by the target company to the seller, or the incurring of certain liabilities by the target company in favour of the seller or a seller group company.

Certain ‘ordinary course’ payments that may fall within the definition of ‘leakage’ may properly be considered to be ‘permitted leakage’. Accordingly, the seller and the buyer can agree that any instances of ‘permitted leakage’ should be excluded from the anti-leakage provisions. Instances of ‘permitted leakage’ can include payments required for the ordinary day-to-day running of the target company. Other instances of ‘permitted leakage’ may also include specifically agreed payments that have been provided for in the ‘locked box accounts’, or payments that are already contemplated by both the seller and the buyer when agreeing on the purchase price.

Completion accounts

Under the ‘completion accounts mechanism’, the buyer and seller agree on a purchase price based on a set of ‘estimated completion accounts’ that are specifically prepared for the transaction. The preliminary purchase price is then paid by the buyer to the seller on completion of the transaction.

Following completion, the preliminary purchase price would be adjusted by reference to ‘final completion accounts’, which are drawn up to the date of completion. The ‘final completion accounts’ are agreed by the seller and buyer as being appropriately reflective of the financial position of the target company on the date of completion, or can be settled/determined by an expert if there is any dispute.

The ‘final completion accounts’ are typically drawn up in accordance with an agreed methodology that would be specified in the SPA. Examples of these methodologies include:

  • Adjustments for cash, debt and working capital in the target company, or
  • An adjustment for the net assets in the target company

Locked box versus completion accounts

The ‘locked box mechanism’ is generally considered a more seller-friendly mechanism. It can offer price certainty at completion, eliminate complex post-completion calculations, and provide greater cost and time efficiency in its negotiation and implementation. The ‘completion accounts mechanism’ is generally seen as a more buyer-friendly mechanism. This is primarily due to the fact that it allows for the purchase price to be readjusted to reflect the financial position of the target company on the date of completion. The pricing mechanism agreed by the parties will depend on the nature of the transaction and the bargaining power of the buyer and the seller.

Comment

The ‘completion accounts mechanism’ and ‘locked box mechanism’ offer different advantages and disadvantages to buyers and sellers, which need to be considered in the context of any transaction.

Under the more buyer-friendly ‘completion accounts mechanism’, the seller bears the economic risks associated with the target company until the completion of the transaction. In contrast, under the more seller-friendly ‘locked box mechanism’, the economic risks (and opportunities) associated with the target company transfer to the buyer at the earlier ‘locked box date’, rather than at the date of completion.

For more information and expert advice on engaging in M&A transactions in the Energy sector, contact a member of our Corporate team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.



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