Locked-box mechanism in M&A transactions

Over the past 10 years, India’s M&A landscape has become more sophisticated, adopting international best practices. Parties are negotiating, at length, clauses relating to purchase price adjustments, completion conditions, representations, warranties and indemnifications in a share purchase agreement (SPA), and the locked box mechanism for determining price is gaining recognition.

Under a traditional completion accounts approach, the purchase price is set using a valuation methodology specified in the SPA and is typically paid as an estimate at completion. Subsequently, the purchase price is adjusted based on the difference between the price paid and price determined from a set of special purpose completion accounts prepared as of the completion date. However, due to regulatory restrictions in India, merger valuation techniques include a mish-mash of the discounted cash flow method, enterprise value method, the net asset method or valuation determined on multiples of earnings before interest, taxes, depreciation and amortization.

Under a locked-box mechanism, the purchase price of the target company is fixed and calculated by reference to historical accounts and financial statements of the target company. The buyer bears the risk in, and reaps of the rewards of, the performance of the target company from the date of the historical financials (the locked-box date) up to completion of the transaction. Since the purchase consideration is fixed upfront, protection against any leakage in the value of the target company between the locked box date and the completion date of the transaction (the gap period) is provided by the seller to the buyer through strong covenants, warranties and indemnities for events since the date of the latest audited accounts.

Raghubir Menon is a partner, Ekta Gupta is a principal associate and Deepa Rekha is an associate at Amarchand & Mangaldas & Suresh A Shroff & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.