With a saturated market at home, US firms are increasingly looking to Europe for deals. According to Dealogic, US private equity firms spent $8.7 billion on acquiring 13 European targets in the first five months of 2013 – already 37 percent more than the entire 2013 total.
But US firms looking to invest must first unpick the ‘locked box’ – a mechanism through which European deals are now so often completed.
Traditionally, deals around the world have been closed using the completion accounts mechanism. In the US, this has continued to be the case. This involves the relevant parties paying an estimated equity price at closing, and then making adjustments to ‘true-up’ the estimated equity price to reflect the actual cash, debt and working capital acquired.
Perhaps unsurprisingly, these final price adjustments are often disputed – so the process can regularly become very lengthy. And as markets have evolved, so too have the mechanisms used to complete deals. As credit conditions loosened in the years preceding the crash, increased buy-side demand led sellers to develop a mechanism more suited to them, which resulted in the rise of the ‘locked box’ in Europe.
At its simplest, a ‘locked box’ is a fixed-price deal. The agreed equity price is fixed in the share purchase agreement (SPA), based on an historical pricing balance sheet, and is the price at which the deal closes. Protection against value leakage after the pricing date is provided by the seller and written into the SPA.
Having avoided disputes around final adjustments, this mechanism seems simple enough. But the process required to get there should not be underestimated. All pricing information needs to be provided pre-completion, typically supported by vendor due diligence, which is a very lengthy process. With completion accounts, certain information can be spread across the pre- and post-deal phases.
There are clear benefits to the seller in using the ‘locked box’ mechanism. There is the obvious certainty of price. Also, ‘locked box’ SPAs are considerably less complex documents – they omit areas such as pricing definitions and specific closing accounts policies and, as such, typically allow just one form of SPA to be adopted for multiple bidders.
Other seller benefits include a greater control of the process and less aggressive price adjustments (the latter often occur because the seller proposes pricing schedules at an early stage of the auction process while multiple bidders are still present).
Buyers enjoy the simplicity of the ‘locked box’, and it also means less time spent by management post-deal. But the trade-off is the buyer’s limited opportunity to adjust the price to reflect the actual assets and liabilities delivered on closing.
It therefore places a lot more focus on those early bidding stages; effective due diligence and consideration of auction tactics is essential. The key to a successful deal is identifying the vital pricing items early, and then making sure the box is locked, while ensuring leakage protections are robust.
The ‘locked box’ shouldn’t be seen by US investors as a barrier to doing deals in Europe. But the changing transaction landscape means investors must take extra care when trying to unlock it.
Colie Spink and Richard Gunn are managing directors at Alvarez & Marsal