The two most common price setting mechanisms in share sales transactions are locked box and completion accounts . Both approaches address the main issue in business sale transactions in a different way - the possibility of adjusting the transaction price due to the time difference between the date of the last financial data of the sold company available to the buyer and the date of the relevant contract (the so-called closing date ). It is common sense to assume that the latest financial data of the subject of the sales transaction are subject to examination by the buyer and then become the basis for negotiations and setting the price on the date of the preliminary contract (so-called signing date ).

Generally, the locked box approach assumes that when signing the preliminary contract for the sale of the company, a fixed price is set for the subject of the transaction to be paid on the date of the actual contract.
For the locked box approach , the date of the last financial data available to the buyer is called the locked box date . The mentioned time difference covers two periods: 1) between the locked box date and the date of signing the preliminary agreement (the period of examining the subject of the transaction and negotiating the terms of the transaction) and 2) from the date of the preliminary agreement to the date of the actual agreement. This second time interval results from the existence of various objective factors precedent (for example, sale of non-operating assets by the company being sold, consent of the Office of Competition and Consumer Protection to carry out the transaction, etc.), after the fulfillment and/or occurrence of which, both parties will finally sign the relevant contract.

Assuming that the subject of the transaction is a package of 100% shares of the company, this fixed price should reflect 1) the value of the enterprise on a debt free cash basis basis, plus 2) the value of cash, minus 3) the value of interest-bearing debt. The value of the enterprise based on debt free cash free is exactly the value of the enterprise without taking into account cash and interest-bearing debt. For the sake of clarity, this picture should be supplemented with non-operating assets and non-operating liabilities - however, most often, the seller of the company transfers these types of assets and liabilities from the balance sheet of the sold company, because the buyer, by definition, is not interested in managing side activities. The value of the enterprise based on debt free cash free , in the case of profitable businesses, reflects the earnings power of the enterprise relating to operating fixed assets (intangible assets and tangible fixed assets) and working capital - here the discounted cash flow model FCFF ( Free Cash) is most often used Flow to Companies ) to determine the value of the company.

In the most restrictive form of the locked box , the final price for the subject of the transaction is set in the signed preliminary contract for the sale of the enterprise without price adjustment mechanisms. Rationally, this price should reflect the value of the company being sold not as of the date of the preliminary agreement (or the locked box date ), but as of the date of the actual agreement.

In the case of profitable businesses, it can be assumed that the final price adopted should be the value of the enterprise on the locked box date plus projected net profits in a reasonably expected transition period. It is reasonable to assume that net profits will materialize in the form of cash accumulation and/or a reduction in debt repaid from the generated cash surpluses. For loss-making companies, the transaction price should sensibly take into account expected net losses from the locked box date , which will generally result in a reduction in cash and/or an increase in debt.

This simplified picture assumes, by default, that the scale of operations of the sold enterprise will be maintained at a similar level during the transition period - i.e. a similar level of working capital and a similar level of operating fixed assets. A similar level of fixed assets means making mainly replacement investments at a level similar to depreciation. It is worth noting here that in the case of a significant level of depreciation costs, the lack of investment outlays will have a significant impact on improving the entity's liquidity and will actually result in an additional increase in cash surpluses at the level of recognized depreciation. In such a situation, instead of net profits, it would be rational to consider the so-called net monetary profits (so-called cash profit).

In the less restrictive form of locked box, the preliminary contract for the sale of the company sets a fixed transaction price along with a mechanism for calculating additional remuneration for the seller in accordance with the passage of time from the locked box date to the date of the actual contract - which results from the lack of certainty regarding the date of signing the actual contract. From a value concept perspective, the stick price will in this case reflect the value of the traded item at the locked box date , and the additional consideration will (or may) relate to the expected generation of net profits (potentially net cash profits) during the transition period. There is also another conceptual possibility - the additional remuneration for the seller is to reflect interest on the price agreed by the parties on the locked box date.

Why locked box ? The closed box refers to three components – working capital, cash and debt. The parties to a company's sales transaction are aware that these three items influence and cancel each other, so they adopt a fixed price for the entire subject of the transaction (i.e. also for these three items). For example, an increase in working capital results in a decrease in cash, free cash can be used to repay debt - which will result in a simultaneous decrease in cash and debt. Consequently, adopting a fixed price for the whole should eliminate the need to examine individual components after the closing date , subject, of course, to identifying irrational actions and actions inconsistent with the preliminary agreement.

Regardless of the detailed form of a locked box, we are generally dealing with a rigidly set price for the subject of the transaction - the enterprise being sold. From the buyer's point of view, this means the risk that in the period before taking over the entity (i.e. signing the actual contract), the economic situation of the subject of the transaction will deteriorate and the buyer will actually overpay. And vice versa - in a hypothetical situation of a significant improvement in the economic situation of the company being sold during the transitional period, it can be reasonably assumed that the agreed price will be below the value of the company being sold as at the date of signing the relevant contract - i.e. the seller will lose.

In addition to the above objective risks for the seller and the buyer, there is also a potential risk, only from the buyer's point of view, of reducing the value of the subject of the transaction based on the transaction between the sold company and the seller - still controlling the company in the transition period. These are the so-called leakage transactions . Such transactions could include, for example, the payment of a dividend, the sale of assets (inventories and fixed asset items) at a reduced price to entities related to the seller, and the granting of loans by the company to entities related to the seller (on preferential terms for these entities). Most often, the restrictions on carrying out this type of transactions during the transitional period, the catalog of permitted transactions, as well as the methods of price adjustment in the event of such permitted transactions are appropriately included in the preliminary company sale agreement.

Taking into account the risks and specific aspects indicated above, most often both parties to the sale of a company with a locked box pricing mechanism use professional transaction advisory services to secure the interests of both parties.

The completion accounts mechanism gives both parties to the transaction the opportunity to more flexibly adjust the final transaction price in line with actual financial results during the transition period. It will be discussed in a separate article.