View from 30,000 feet

When advising new US clients on their investment and divestment transactions, we often encounter points of English law and practice that our clients find surprising.

While such issues are always surmountable, we find that prior familiarity with the key points can allow for superior transaction planning, outcomes and a reduction in timelines and costs.

The purpose of the “View from 30,000 feet” series is to provide a brief, high-level introduction to the key issues our US clients encounter on a regular basis with a view to reducing the number of surprises. The first notes will focus on some key UK purchase agreement points and subsequent editions will branch out into other areas relevant to institutional US clients.

These notes are not exhaustive (nor are they intended to be) as each transaction will turn on its facts. We are always available to discuss and engage with any follow up questions and we hope you the series useful.

Issue 1: “Locked Box” purchase price adjustment mechanics

Set out below is a brief note on Locked Box price adjustment mechanics in a UK purchase agreement that may be unfamiliar to a US buyer or seller of a UK private company.

Pricing mechanisms and adjustments: Completion Accounts mechanics (i.e. a post-closing “true-up”) are often used in UK transactions between strategics or where the buyer is in a position to dictate the price adjustment mechanism. However, in the context of an acquisition of a portfolio company from a private equity (PE) investor, or where the seller can dictate, it is typical that a “Locked Box” mechanism will be used. This structure allows for the economic risk of the business to transfer as at a prior accounts date (rather than at closing), thereby removing the need for a post-closing “true-up”, and is typically set up as follows:

• Locked Box Date: for the purposes of the transaction documents the target is deemed “sold” as at an agreed historic balance sheet date known as the “Locked Box Date”.
• Financial Due Diligence (FDD): financial statements are prepared as at this date and FDD is undertaken on these. Economic risk and benefit (i.e. cashflow) in the business after this date belongs to the buyer.
• Ticker: the seller is compensated for the delay in receipt of their consideration on the Locked Box Date by the application of a daily interest rate (often referred to as the equity “Ticker”) which will often run from the Locked Box Date to the date of closing.
• Leakage: US clients are often concerned about the risk of the seller stripping value from a target in the period between the Locked Box Date and closing. This is a legitimate concern and is covered off by the inclusion of a “Leakage Covenant” in the purchase agreement by which the seller is required to make the buyer whole on a £ for £ basis in general terms for any value received by the seller from the target group (whether by way of dividend, forgiveness of a liability or otherwise) between the Locked Box Date and closing.
• Permitted Leakage: certain legitimate categories of value due to the sellers are carved out of the Leakage Covenant (such as sponsor monitoring fees) these items are grouped together and labelled as “Permitted Leakage”.
• EV to Equity Bridge: in all cases it is important that a clear financial model is produced by the parties showing the bridge from the EBITDA-driven headline price to the equity price and which sets out the agreed individual deductions.