A business acquisition has a number of key moments. Two of them are the date of economic transfer and the closing date. Those two moments can coincide. But often they do not. In both cases, different mechanisms come into play. We call them closing accounts and locked box, respectively. And here's what you need to know about them.
Let's go back to those two key moments. We distinguish between the economic transfer date and the closing date. The first refers to the moment when the business (in the economic sense) is at the expense and risk of the buyer. The closing date is the moment when legal ownership is transferred. Often this is the share delivery at the notary. From that moment on, the buyer is really in charge.
When those two moments coincide, we speak of a closing accounts mechanism. When the legal transfer occurs before the economic transfer, we speak of a locked box mechanism. Both affect the acquisition process and the choices you make as buyer or seller. Fun fact: in the Netherlands we are mostly of the locked box form. While abroad closing accounts is commonplace. But don't let that guide you.
Differences
First, let's look at the differences. The following diagram shows where the mechanisms differ.
Locked box mechanism
Economic transfer date
This is before the legal transfer date (closing date). Often retroactive to January 1 of the year in which the closing takes place.
Takeover balance
With a locked box, the acquisition balance sheet is ready before closing. It can therefore be reviewed as part of the due diligence process.
Cash, debt and working capital
A previous article outlined the importance of (the calculation of and agreements on) cash, debt and net working capital in an acquisition. This calculation takes place on the acquisition balance sheet and can therefore be completed before closing.
Valuation
Because there are different economic transfer moments, the valuation is also different.
Purchase price
All elements for the purchase price determination are definitively known before closing. The exception to this are any earn-out outcomes. Of course, there are guarantees to be given by a seller.
Bridging between economic transfer date and legal transfer date (closing)
Because these are two different moments, there is a bridging period. In this, the profits and risks already lie retroactively with the buyer. This does not apply to control/control. Therefore, the following types of agreements are usually made:
- Agreements on maximum withdrawals by seller during that period (not only dividends, but also rewards and other pass-throughs).
- Agree on an appropriate interest rate on the purchase price for seller, since payment is not made until closing. This is an outcome of negotiation.
- Agree on key decision-making at the company during that bridging period.
Closing accounts mechanism
Economic transfer date
This is the same as the legal transfer date (closing date).
Acquisition balance sheet
The acquisition balance sheet is not ready until after closing. It is therefore not reviewed until after that. This also applies to negotiations about any findings from it.
Cash, debt and working capital
These final calculations - often fodder for discussion - can only take place after obtaining the acquisition balance sheet after closing date.
Valuation
Because there are different economic transfer moments, the valuation is also different.
Purchase price
Because the final acquisition balance sheet and developments up to closing date still play a role in the final purchase price determination, the purchase price as of the closing date is still provisional. The final determination only takes place after closing.
Bridging between economic transfer date and legal transfer date (closing)
Because both moments coincide, agreements such as locked box are not necessary. An interest payment only covers any difference between the provisional and final purchase price.
Pros and cons
So much for the differences. But are there advantages or disadvantages to either mechanism? There are. Biggest advantage of a locked box mechanism is that the purchase price is final at the actual notarized transfer. This is different with a closing accounts mechanism. Here the calculation of the purchase price extends over the period after the transfer. And that includes all possible discussions about it.
All the more reason to lay down extensive calculation and process agreements in the purchase contract for the closing accounts form. This often makes this form of transaction more laborious and therefore more expensive. Yet a locked box mechanism also has disadvantages. You will have to make very good agreements about the bridging period. Also consider the calculation of an appropriate interest rate on the purchase price.
Which form is most appropriate?
Which form is most suitable for buyer or seller always depends on the actual circumstances. Determining factors include the length of time between economic transfer and closing, the availability of good information and the risk profile.
But so do the negotiation outcomes when it comes to the contractual elaboration and calculation of valuation, cash/debt/net working capital and interest. Because of these and other complexities, it is more than wise to always seek proper advice.
