In any M&A transaction, one of the fundamental matters to be agreed by the parties (usually at an early stage) is what approach will be used to calculate the purchase price, including whether or not there will be any post‑completion adjustments. This article looks at recent global trends we have observed and how they compare to New Zealand market practice, particularly on the use of locked box mechanisms versus completion account adjustment mechanisms. It draws from the findings of the DLA Piper 'Global M&A Intelligence Report 2016' (Report).
For a brief summary of locked box and completion account concepts, please click here.
Locked box v completion accounts
Our Report affirms completion accounts (as opposed to a locked box or no price adjustment mechanism) as the most common approach in M&A globally, with 69% of surveyed share deals employing a completion accounts mechanism. However, significant regional variances sit behind that statistic. In the US and Australia, completion accounts remain the market standard, with locked box mechanisms very rarely used in domestic deals. However, in Europe, locked box has become the dominant approach for larger deals, particularly where an auction process is used (71% of surveyed auction transactions in Europe were done on a locked box basis).
The Report also affirmed that the nature of the buyer and the seller has a material impact on the chosen pricing approach. Trade buyers and sellers are much less likely to accept a locked box approach, preferring the 'wash-up' approach that comes from completion accounts. In Europe, for example, more than 70% of trade to trade deals were done on a completion accounts basis. PE buyers and sellers, on the other hand, clearly regard a locked box approach more favourably. This is not surprising given the price certainty and reduced prospect of dispute that locked box mechanisms can provide.
In our experience, New Zealand market practice follows the US/Australian approach, with completion accounts being favoured, which is unsurprising given our tax landscape. That said, we did see a number of transactions done on a locked box basis in 2015 and 2016.
The decision regarding whether a locked box is an appropriate mechanism for a transaction will depend on a number of factors in addition to the nature of the buyer and the seller, including: the extent to which working capital fluctuates in the target business, the target's rate of growth, the time delay between the proposed locked box date and completion, the importance of price certainty to the parties, the appetite of the seller to commit the target business to tight pre-completion obligations, and the parties' desire to minimise the chances of a dispute arising regarding the completion accounts.
Basis of completion accounts
Common completion account adjustment mechanisms include net debt, net working capital and net assets, or a combination thereof. The approach agreed by the parties will naturally depend on a variety of factors relevant to the particular transaction, including the respective parties' preferences, the nature of the target's business (including its key value drivers) and the valuation methodology used by the buyer in calculating the purchase price. Our Report reveals a number of trends:
- Net debt and working capital are the most commonly used metrics across all surveyed jurisdictions. 81% of surveyed deals in the US, the UK, Continental Europe and Australia had a price adjustment mechanism that was based on net debt, working capital or a combination of the two. Of that, 43% of surveyed deals had a net debt and working capital adjustment, 30% had only a working capital adjustment and 8% had only a net debt adjustment.
- Using only a net debt adjustment mechanism is more common in Continental Europe (33% of surveyed deals), with this approach being much less frequent in other jurisdictions (10% in the UK, 4% in the UK and negligible in the US).
- In the US, working capital is the metric most focused on, with 91% of surveyed deals including a working capital price adjustment mechanism.
- Net asset adjustment mechanisms are not used frequently in any of the surveyed jurisdictions. Australia saw the highest proportion of deals using a net assets adjustment mechanism at 24%, compared to 14% globally, 10% in the UK, 12% in Continental Europe and 6% in the US. We suspect the relative lack of popularity of net asset adjustment mechanisms is down to the more common practice of valuing targets as a multiple of EBITDA or EBIT.
In New Zealand, our experience is that most deals that include a post-completion adjustment mechanism are done on a 'debt free - cash free' basis with a working capital adjustment.