News From the Locked Box



In German share deals, two types of purchase-price clauses predominate: on the one hand, the adjustment of a base purchase price by the net debt of the target company and variations in its working capital as of the closing; on the other hand, the calculation of the purchase price on the basis of the latest audited balance sheet of the target company and interest payments on such purchase price for the period between the balance-sheet date and the closing ("locked box"). In recent times, a combination of both mechanisms has been used as an alternative: the calculation of the purchase price as of an effective date between the date of the last audited financial statements and the closing and interest payments for the period between such effective date and the closing. This article briefly discusses the established mechanisms and then explains the new alternative.

Determination of the Purchase Price as of Closing

In recent years, the most common purchase-price mechanism used in share deals—on a simplified basis—is as follows: base purchase price plus cash less financial debt plus excess or less shortfall in working capital equals final purchase price.

The reason for this mechanism lies in the valuation of the target company. Buyers typically value target companies using the discounted-cash-flow method and/or an enterprise- value multiple, such as a multiple of the target company's EBIT or EBITDA. Both types of valuations have in common the fact that the value of the target company—and thereby the purchase price—is determined in two steps. First, the so-called enterprise value is determined, which is the present value of the target company's expected payments to its equity and debt holders. In order to determine the target company's equity value and thereby the purchase price, the market value of the target company's debt, which normally equals its book value, then has to be deducted from the enterprise value. Furthermore, nonoperating assets, particularly excess cash and cash equivalents, are compensated separately and therefore have to be added to the purchase price. Second, the target company's working capital is compared to a certain target workingcapital figure. To the extent the target company's working capital exceeds or falls short of such target, the purchase price is increased or decreased, respectively.

The advantage of this purchase-price mechanism is that the balance-sheet items...

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