The Share Purchase Agreement (SPA) and closing M&As

The Share Purchase Agreement (SPA) and closing M&As

Author: Joris Kersten, MSc

Kersten Corporate Finance: Selling & buying companies in The Netherlands (M&A). www.kerstencf.nl

Valuation training: 4th – 8th November 2024, Valuation & deal structuring, at Amsterdam South. In addition I provide inhouse corporate finance training at leading organisations all over the globe, from New York to Hong Kong. www.joriskersten.nl

Source used: Bedrijfsovername. Wolters Kluwer 2023. De Overnameovereenkomst. M. van Buuren & Y. van Benten.

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Introduction

Within a share purchase agreement (SPA) the most common mechanisms to close a deal are:

1) “closing accounts”, and,

2) a “locked box”.

As a rough rule of thumb you could argue that the “closing accounts mechanism” is more friendly for the buy side.

And the “locked box mechanism” can be seen as more friendly for the sell side.

On the other hand, a “closing accounts mechanism” can be a suitable mechanism when the seller expects very good returns in the period before the “economic date” and “legal date” of the transaction.

Reason is that with closing accounts these good results will still be for the seller !

So for example for high growth companies, it can be beneficial to use closing accounts when selling.

On the other hand, a locked box mechanism is popular under both sellers and buyers, especially here in Europe.

Reason is that with a locked box you will be certain about the purchase price.

And chances on discussion about the purchase price will be minimised with this method (locked box).

Let’s now take a deeper look at these 2 closing methods in the SPA.

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Closing accounts mechanism

Over the globe, a closing accounts mechanism is still the standard in SPAs for M&As.

With this method an estimate will be made for the level of “net debt” at the closing moment of the deal.

These estimates of net debt are made on for example:

-A provisional acquisition balance sheet (“preliminary closing accounts”), or,

-Intermediate financial information (“management accounts”).

At the closing of the deal a preliminary purchase price will be paid for the deal.

This based on an estimated “net debt”.

Within a certain period after the closing, for example within three months, a final acquisition balance sheet will be constructed.

And this final acquisition balance sheet often needs to be checked off by an accountant.

Because this is often negotiated in the SPA between parties.

The final acquisition balance sheet will be compared to the preliminary balance sheet, with a focus on “net debt”.

And the “delta” in “net debt” between the 2 balance sheets needs to be settled between the parties in the acquisition !

Buyer has the initiative to construct the final acquisition balance sheet.

So buyer can try to make purchase price corrections to their own advantage.

This can lead to disputes about the deal, and the purchase price corrections for “net debt”.

The second closing mechanism; the locked box, gives parties less chance on disputes on “net debt”, and will be discussed now.

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Locked box mechanism

The locked box mechanism is popular in Europe.

The mechanism gives more certainty about the final purchase price including full agreement on “net debt”.

With a locked box the final purchase price will be calculated based on the most recent reliable numbers available.

Think of the last audited annual report, from for example 31st December of the last book year.

The effective date of the deal (the “economic acquisition date”) will then be for example January 1st.

This is one day after the “balance sheet date” of 31st December on which the full purchase price is calculated, including net debt.

At January 1st the company will then be sort of “saved” in a box for the buyer.

And this box can not be opened anymore (the locked box) !

So all in- and outflows from the box will be carefully monitored.

Locked box compensation for seller

The results of the company between the economic date (or effective date), and the closing (legal acquisition date), will be for the buyer.

So the purchase price is financially set based on for example last 31st December.

But it will be paid at the closing date (the legal acquisition date).

The seller is economically NOT owner of the company anymore from this effective date on.

So often seller gets a compensation for the time in between the economic date and legal date.

This since the company results are for the buyer from the economic date on, but the acquisition purchase price is only paid at the closing date (legal date).

So technically buyer “borrows” the purchase price from the economic date to legal date.

And within this perspective, compensation in the form of an interest rate makes sense !

Further conditions

With a locked box the seller can not subtract funds from the business after the economic date.

This although seller is still the "legal owner" at that point in time.

And we call this a ban on “leakage” for the seller, like for example:

-Dividends and paying out reserves;

-Unusual payments (e.g. bonusses) to parties related to the seller;

-Intercompany transactions not at “arms length” (market conditions);

-Transaction related costs like M&A advisor fees.

In general the ban is broader, so basically only actions can take place based on an “ordinary course of business”.

On the other side, there is also “permitted leakage”, like management fees to the seller, cause he/ she is still running the business.

This is all negotiated in the SPA between M&A lawyers in cooperation with M&A corporate finance advisors.

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I hope this blog was useful,

See you next week again, best Joris

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Source used: Bedrijfsovername. Wolters Kluwer 2023. De Overnameovereenkomst. M. van Buuren & Y. van Benten.