The world of mergers and acquisitions (M&A), can often seem overly confusing–mainly due to the common use of industry jargon and other complexities. It feels as if navigating a merger requires a thesaurus, not to mention an endless list of financial, legal, and HR boxes to check off.
In this article, we’ll focus on an integral aspect of the financial part — price mechanisms that impact your share purchase agreements, or SPAs.
The Unseen Machinery of Deal-Making
Amidst the procedural routines and legal formalities that characterize M&A, the share price mechanism is one of the lesser-known parts of a deal. Let’s break down this relatively known, yet crucial aspect of a merger or acquisition and discuss its role in the success or failure of a deal.
Understanding Price Mechanisms in SPA
During an M&A transaction, a completion mechanism is often used to determine the final price that a buyer needs to pay to acquire the shares of another company. In most deals, there are two commonly-used strategies: completion accounts and locked box. Locked box deals are now very common in the UK and across Europe, particularly on competitive auction processes and where private equity is involved.
Types of Price Mechanisms
- Locked Box Mechanism: Using this strategy, both parties examine the company’s most recent financial statements and agree on a final purchase price. There is no post-completion adjustment. In this sense, the locked box mechanism establishes a price at the onset of the deal and uses it to anchor the transaction.
- Completion Accounts: On the other hand, completion accounts allow for an adjustment in the purchase price after the deal has been completed. Using this strategy, both parties establish a preliminary purchase price by agreeing on an estimate of what the equity value will be as of the date of completion. But, there is also room to negotiate an adjusted closing price once the deal has been completed.
- Factors Influencing the Choice of Price Mechanism: The choice between a locked box and completion accounts depends on the nature of the deal. Namely, the size and complexity of the deal as well as the accuracy of the initial purchase price.
Pros and Cons of Different Price Mechanisms
Navigating the landscape of price mechanisms within SPAs involves a nuanced understanding of their advantages and challenges. Let’s dissect the two primary mechanisms, shedding light on their respective advantages and drawbacks.
Locked Box Mechanism
- Advantages and Challenges: Delving into the advantages, the locked box mechanism introduces a level of certainty that simplifies the transaction process. However, its rigidity may sow the seeds of potential disputes concerning the nuanced aspects of accounting specifics. Additionally, many deals take time to come to fruition and the value of the business may have shifted during this time.
- What is locked box leakage? An obscure term you’ll often hear when dealing with a locked box pricing scenario is leakage, and it’s an important consideration. In the locked box model, setting the price requires special attention from the buyer’s perspective, emphasizing the need to establish suitable constraints on the permissible outflow of funds from the company (the so-called leakage), e.g. dividend payments.
- Situations Ideal for Locked Box: A locked box mechanism is suitable for businesses with foreseeable cash flows where it is fairly easy to establish a concrete price. It’s also ideal when both parties want the deal to be closed fairly quickly.
Completion Accounts
- Flexibility and Risks: Completion accounts, on the other hand, offer a degree of flexibility. They epitomize adaptability, allowing adjustments based on the actual financial positions–even after the deal has closed. However, this flexibility is not without its complexities. In some cases, it can lead to disagreements over the post-merger financial adjustments.
- What are the Completion Accounts Adjustments? They are financial modifications made during the finalization of a transaction such as Net Debt and Net Working Capital adjustments. Net Debt Adjustment aims to reconcile the initially estimated values with the actual financial position at the closing date. In Net Working Capital Adjustment, the buyer seeks the target’s closing Net Working Capital to match the cash flow used in determining the purchase price, termed as a normalized level. However, this may differ from the expected level at closing due to day-to-day fluctuations. The Normalized Net Working Capital is the fair level agreed upon by the parties in the pricing model, adjusted for typical business fluctuations.
- Tailoring to Specific Business Models: Suited for businesses with dynamic financials, completion accounts function as bespoke solutions, accommodating the need for post-closing adjustments in alignment with distinct business models.
Negotiating Price Mechanisms: Best Practices
As we transition to the negotiation table, the tapestry of deal-making unfurls, demanding precision, astuteness, and a strategic finesse reminiscent of a chess grandmaster.
The Most Important Aspects of the Negotiation Process
- Collaborative Negotiation Strategies: In regard to negotiations, a collaborative effort is almost always the most valuable route. In general, it’s best to emphasize mutual benefits over adversarial posturing, the aim is to foster an environment conducive to successful transactions.
- Establishing Clear and Measurable Performance Metrics: To avoid disputes, it’s best to establish clear performance metrics that can be easily measured. Defining metrics with surgical precision diminishes ambiguity, paving the way for transactions marked by seamlessness.
- Balancing Seller and Buyer Interests in Pricing: Negotiating a fair price involves a delicate tightrope walk, ensuring a fair price for the seller while also avoiding overpaying for an asset that might appear more valuable than it really is.
- Importance of Professional Advisors in Negotiations: Engaging financial and legal experts is typically a necessity in these types of transactions. Bringing on professional counsel can help you navigate the intricate landscape with astuteness and ensure comprehensive representation for both parties.
Legal Implications of Price Mechanisms
Venturing into the legal arena of M&A transactions requires meticulous consideration, an examination of potential pitfalls, and a calculated approach to risk mitigation, akin to a legal maestro crafting a symphony of compliance.
Your Legal Checklist for Negotiations Around Price Mechanisms
- Drafting Enforceable Price Mechanism Clauses: The crafting of price mechanism clauses is akin to sculpting a legal masterpiece. Each word must withstand the scrutiny of legal interpretation and enforcement. The goal is to create clauses that not only reflect the intent of the parties involved but also provide a robust framework for the agreed-upon price mechanisms.
- Addressing Ambiguities and Potential Disputes: In the pursuit of legal resilience, attention to potential ambiguities is paramount. Ambiguous clauses can be breeding grounds for disputes, disrupting the harmony of the transaction. Therefore, a thorough examination of the SPA is essential to pinpoint and rectify any language that may give rise to conflicting interpretations.
- Legal Due Diligence on Financial Provisions: Just as financial due diligence is integral, legal scrutiny of financial provisions ensures a comprehensive understanding of the legal implications embedded in the transaction. This involves a meticulous examination of the legal framework governing financial elements, identifying any potential legal risks or non-compliance issues.
Mitigating Risks Through Price Adjustments
As the narrative progresses to the post-closing phase, strategic considerations become pivotal, ensuring the equilibrium of the agreed-upon price, akin to a postlude that resonates with financial harmony.
Risks and Key Areas to Watch for
- Understanding Common Post-Closing Adjustments: Post-closing adjustments emerge as pragmatic measures, addressing working capital, indebtedness, and net asset value – the custodians of financial fairness post-transaction.
- Defining Criteria for Adjustments: Articulating criteria for adjustments becomes an exercise in precision, aligning seamlessly with the dynamic rhythm of the business, minimizing room for interpretation and discord.
- Strategies for Contingency Planning and Risk Mitigation: Contingency plans materialize as safeguards, navigating unforeseen circumstances, and ensuring a harmonious transition through the unpredictable waters of post-closing financial adjustments, much like a strategic finale ensuring the coherence of the entire financial symphony.
Final Thoughts: Decoding Price Mechanism Considerations
We hope that you’ve found this article on price mechanisms valuable, and ideally, you even learned some things along the way. If you’re interested in reading more, please subscribe below to get alerted of new articles as we write them.
If you find yourself in the midst of your own merger or acquisition then please contact the Acquinox team today — we’d love to help guide the process.
