In European transactions, with fewer buyers in the current market with access to credit, sellers are faced with receiving lower prices for their assets, with buyers increasingly concerned to avoid paying “over the odds” in markets where the success of an investment can not be assumed. By using an earn-out or deferred/contingent payment mechanisms in the calculation of the purchase price, buyers seek comfort that assets are realistically priced. Such mechanisms are being used with greater frequency in European M&A transactions.
In a shift back to pre-boom deal features, European buyers are increasingly insisting on the preparation of completion accounts rather than submitting to the more seller-friendly ‘locked box’ mechanism, which became a tool popular in many European and US private equity driven sale processes.
The locked box is a mechanism through which the parties agree a price payable for the target company based on accounts (often unaudited) drawn up to a date prior to signing. The “box” is then locked by the seller giving indemnities or undertakings not to extract dividends or any other form of value from the target group prior to completion of the deal.
The advantage for the seller of this mechanism is that it gives certainty as to the determination of the price, with little ability for the buyer to reclaim value after completion. It also leads to a quicker process of execution, with no necessity to draw up and agree completion accounts. However, such a mechanism places the onus firmly on the buyer to conduct detailed financial due diligence in advance of signing.
Even during the headier seller-friendly times, the ‘locked box’ approach was not something widely used in M&A deals in Asia. However, the use of completion accounts to verify assumptions underpinning the pricing of deals is becoming increasingly prevalent.
In Europe, reflecting the “distressed” nature of some sellers, there has been a rise in the use of retention or escrow accounts for safeguarding money in case of a claim under the warranties or other parts of the sale documentation. In that context, the retention account route has brought new concerns, these being that the escrow money will usually only attract very low interest rates and parties have had to consider the risk of bank default as a real possibility rather than a theoretical risk.
There has also been a return to ‘Clawback’ and ‘Put Options’ in the event that the fundamental terms of the deal are not fulfilled.