Completion Accounts vs Locked Box: Which Suits Your Deal?

Completion accounts and a locked box are the two mechanisms used in UK share sales to turn an agreed valuation into an actual price. Completion accounts fix a provisional price at completion and then adjust it, up or down, once the target company’s real cash, debt and working capital position on the completion date has been measured. A locked box fixes the price in the contract by reference to a historic balance sheet, transfers the economic risk and reward of the business to the buyer from that historic date, and protects the buyer by making the seller repay, pound for pound, any value taken out of the company between then and completion.

The choice is not a technicality. It decides who carries the risk of trading between signing and completion, whether the seller walks away with a final figure or waits months for one, and how likely it is that the two sides end up in front of an accountant arguing about stock provisions. We act for buyers and sellers on mergers and acquisitions across the SME and owner-managed market, and in our experience the pricing mechanism is settled too late and with too little thought in a large proportion of deals.

Most published guidance on this subject is written for private equity and corporate finance audiences, where the locked box has been the default for years. That guidance does not translate cleanly to a company with a turnover of two or three million pounds, management accounts prepared by a part-time bookkeeper and no audit. Below we set out how each mechanism actually works, what the jargon means in plain English, and the honest answer to the question an owner-managed business usually wants settled: does a locked box suit a deal like mine, or not?

Why the headline price is never the price

Almost every negotiated share sale starts with a figure that is not the amount the buyer will pay. A buyer offers a value for the business as a trading operation, independent of how it happens to be financed on any particular day. That figure is the enterprise value. What the seller actually receives for their shares is the equity value, and the bridge between the two is the company’s cash, its debt and its working capital.

The reason is straightforward. Two identical companies with the same customers, the same margins and the same staff are worth the same as businesses. If one of them is sitting on £400,000 of surplus cash and the other has a £400,000 bank loan, the shares in the first are plainly worth more. Neither mechanism changes this logic. They differ only in the date at which the measurement is taken and in who carries the risk of the figures moving afterwards.

This is a share sale question. Where the deal is structured as a sale of trade and assets, the price is usually built up from a schedule of the assets being transferred, and these mechanisms are either not used or used in a cut-down form. If you have not yet settled the structure, read our comparison of a share sale against an asset sale first, because that decision comes before this one.

What “cash free, debt free” actually means

“Cash free, debt free” is the single most misunderstood phrase in SME deal negotiation. It does not mean the seller has to clear the company’s bank account and repay its borrowings before completion. It means the price is calculated as though they had.

In practice, the parties agree an enterprise value, and then at the measurement date they add the company’s cash and deduct its debt to arrive at the price for the shares. The seller keeps the benefit of surplus cash and bears the cost of borrowings, which is exactly the economic outcome you would get if the company had been emptied and cleared immediately before the sale, without anybody actually having to do it.

The arguments are never about the principle. They are about what counts. Cash is usually easy. Debt is not, because buyers push to treat as debt a range of items that do not appear under “loans” in the accounts. The negotiated definition of “debt-like items” commonly covers:

• Bank loans, overdrafts, invoice discounting balances and asset finance, including early repayment charges and break costs.
• Director loans owed by the company, and any unpaid dividends already declared.
• Corporation tax, VAT and PAYE owed but not yet paid, where these are not already picked up in working capital.
• Deferred or unfunded liabilities such as dilapidations on leased premises, pension deficits, accrued but untaken holiday, and deferred consideration still owed on an earlier acquisition.
• Costs of the sale itself, including the seller’s adviser fees and any transaction bonuses promised to staff.
• Capital expenditure the business has committed to but not yet paid for, where the buyer argues it is a liability rather than normal trading.

Equally, not all cash is free cash. A buyer will argue that cash held as a customer deposit, cash required by a regulator or a bonding arrangement, cash sitting in a client account, or the minimum float a business needs to open its doors on Monday morning is not available to the seller. These are described as restricted or trapped cash, and the right answer depends on the business, not on a standard form.

Get these definitions written down in the heads of terms in words, not just in a spreadsheet. A buyer who agrees an enterprise value and then produces a long list of debt-like items at the drafting stage has effectively reduced their offer after the event, and the seller has lost the leverage to push back.

What “normalised working capital” actually means

Working capital is the money tied up in running the business day to day: stock and work in progress, plus what customers owe you, less what you owe suppliers and other trade creditors. A buyer paying for a trading business expects to receive it with a normal amount of working capital in it, because a company stripped of stock and with every debtor collected is a business that cannot trade on Tuesday.

“Normalised” means a level that reflects how the business ordinarily runs, rather than the level on one particular day. The target is usually set by averaging the monthly position over the previous twelve months, sometimes with adjustments to strip out one-off items or a known seasonal distortion. Where the business is genuinely seasonal, a single twelve-month average is a poor target, and the parties either pick a month-specific target or a range.

The mechanic then works in both directions. If working capital at the measurement date is above the target, the buyer pays the excess, because they are receiving more stock and more debtors than they bargained for. If it is below the target, the price comes down. This matters commercially, because it removes the incentive a seller would otherwise have to run stock down, chase debtors hard and stretch suppliers in the weeks before completion. All three of those tactics turn working capital into cash, and the adjustment takes the benefit straight back out again.

The practical trap in SME deals is that the target is often set from management accounts that have never been prepared on a consistent basis. If stock was counted properly in March and estimated in June, a twelve-month average built from those numbers is not a target, it is a guess. Where that is the position, we would usually advise a seller to invest in getting the numbers tidied up before going to market, which is part of what vendor due diligence is for.

How completion accounts work

Completion accounts are the traditional mechanism and still the default in a large proportion of owner-managed deals. The price is calculated twice: once provisionally, so that money can change hands on the day, and once properly, after the event.

Step one: the estimate at completion

Shortly before completion the seller produces an estimate of the company’s cash, debt and working capital at the completion date. That estimate feeds the formula in the share purchase agreement, producing an estimated equity price, and that is the figure actually paid on the day. Everything about the estimate is provisional. Our guide to what a share purchase agreement does explains where this sits in the contract, which is usually a dedicated schedule rather than the body of the agreement.

Step two: preparing the completion accounts

After completion, one side prepares a completion statement setting out the actual position at the completion date. The buyer usually prepares it, because the buyer now controls the company and its records, and the seller is given a defined period to review and object. Typical periods in SME deals run to around 30 to 60 working days for preparation and 20 to 30 working days for review, though they are negotiated and nothing is standard.

Whoever prepares it has an advantage, because accounting judgment moves numbers. A buyer-prepared statement will tend to take a cautious view of stock obsolescence, bad debt provisions and accruals, and every one of those judgments reduces working capital and therefore the price. Sellers should press for genuine access to the records during the review period, and for the right to have their own accountant look at the working papers.

Step three: the accounting rules that decide the numbers

This is the part most guidance skips, and it is where completion accounts disputes are won and lost. The schedule should set out a hierarchy of accounting bases, applied in strict order, so that there is a single right answer to each question rather than a range of defensible ones.

The structure that the courts have had to interpret looks like this. In Flowgroup plc (in liquidation) v Co-operative Energy Ltd [2021] EWHC 344 (Comm), decided on 19 February 2021, the completion statement had to be drawn up in accordance with, in the order shown, the specific accounting policies set out in the agreement, then to the extent not covered by those, a basis consistent with the target’s existing accounts, and then to the extent not covered by either, UK GAAP. The court treated those bases as mutually exclusive and applied in that sequence. The dispute, which went to expert determination and then to the Commercial Court, turned substantially on how that hierarchy operated.

The lesson for an SME deal is not that you need a court-tested schedule. It is that the specific accounting policies at the top of the hierarchy are where you fix the handful of judgments that actually move your price. If stock valuation, work in progress recognition, bad debt provisioning or accrual policy matter in your business, write a specific policy for each one and leave nothing to a general reference to UK GAAP.

Step four: the true-up

Once the completion accounts are agreed or determined, the final equity price is compared with the estimated price paid on the day, and the difference is paid one way or the other. If the final price is lower, the seller repays the buyer. If it is higher, the buyer pays the seller.

A seller who has already distributed the proceeds is not a reliable source of a repayment, so buyers routinely insist that part of the price is held back. That is normally done through a retention held in a solicitor’s account or an escrow account with a bank, released once the accounts are settled. The retention should be sized against the realistic range of the adjustment rather than plucked from the air, and the seller should insist the SPA says plainly that the retention is the buyer’s only recourse for a downward adjustment, so that the claim cannot also be run as a breach of warranty. This is a different structure from deferred consideration, where part of the price is genuinely postponed, and different again from an earn-out, where part of the price depends on future performance. A deal can carry all three at once, and the interaction between them needs working through.

Step five: what happens if you cannot agree

Completion accounts schedules almost always provide that an unresolved dispute goes to an independent accountant, acting as an expert and not as an arbitrator, whose decision is final and binding in the absence of manifest error. The expert is usually appointed by agreement, failing which by the President of the Institute of Chartered Accountants in England and Wales on either party’s application.

Expert determination is quick and comparatively cheap, and that is the point of it. What sellers and buyers often do not appreciate is how little room there is to challenge the outcome. The Court of Appeal considered the boundary in Barclays Bank plc v Nylon Capital LLP [2011] EWCA Civ 826, handed down on 18 July 2011, where the question was whether proceedings for a declaration on the meaning of an agreement should be stayed because the issue fell within an expert determination clause. The court held that whether a question of construction falls to the expert or to the court is itself a question of construction of the clause, with no presumption either way. Where the parties have genuinely entrusted a question of construction to the expert, the expert’s decision is final and conclusive and is not open to review merely because it was wrong in law, unless it can be shown that the expert has not performed the task assigned to them.

In practical terms: a determination you dislike is very hard to unpick. The protection is in the drafting, not the appeal. Define carefully what the expert may decide, make clear whether questions of contractual interpretation are inside or outside their remit, require a reasoned decision, set a timetable, and deal expressly with how their fees are borne. We advise on these clauses as part of contract dispute work as well as on the deal itself, and the two perspectives are not the same.

How a locked box works

A locked box reverses the sequence. Instead of measuring the company at completion and adjusting afterwards, the parties price the deal off a balance sheet that already exists, write a fixed number into the contract, and then make sure nothing escapes from the company in the meantime.

The locked box date and the locked box accounts

The locked box date is a historic balance sheet date, usually the company’s last statutory year end or a recent month end for which a properly prepared balance sheet exists. The cash, debt and working capital position at that date is used to bridge from enterprise value to equity value, exactly as described above, and the resulting figure is the price. There is no post-completion adjustment.

Economically, the buyer is treated as owning the business from the locked box date. Profits generated after that date belong to the buyer, and losses are the buyer’s problem, even though legal ownership does not pass until completion. That is why the quality of the locked box accounts matters so much: the buyer is paying a fixed price off them with no second look.

Choosing the date is a balance. Too recent and there is no properly prepared balance sheet to work from, and the buyer has not had time to diligence it. Too historic and the gap to completion grows, which increases both the leakage risk and the argument about who should get the profits earned in between. For most SME deals a locked box date more than six months before completion starts to look uncomfortable.

Leakage

Leakage is value leaving the company for the benefit of the seller or its connected parties between the locked box date and completion. Because the buyer has paid a price fixed on the locked box date position, any such extraction reduces what they receive for an unchanged price. The usual list includes:

• Dividends and other distributions declared or paid.
• Repayment or waiver of loans owed by the seller or a connected party to the company, or the company assuming a liability of the seller.
• Payments to the seller or connected parties that are not on arm’s length terms, including inflated management charges, rent and consultancy fees.
• Bonuses, salary increases and benefits awarded to the seller or to directors outside the ordinary course.
• Transfers of assets to the seller or a connected party at less than market value, including cars, property and intellectual property.
• The seller’s transaction costs, including corporate finance and legal fees, where they are paid by the target rather than by the seller personally.
• Any tax the company suffers as a result of one of the above.

Permitted leakage

Permitted leakage is the list of things the seller is expressly allowed to continue doing. It is a negotiated carve-out, not a standard clause, and it usually covers ordinary salary, pension contributions and benefits at existing levels, genuine arm’s length trading between the target and seller group companies, payments the buyer has priced in and specifically agreed, and amounts capped at a stated figure.

Two points are regularly got wrong in owner-managed deals. First, if the seller intends to keep drawing their usual mix of modest salary and regular dividends up to completion, that dividend stream must be inside permitted leakage, with a cap, or it is leakage and it is repayable. Second, permitted leakage should be defined by reference to specific amounts or formulas rather than vague wording such as “in the ordinary course”, because the latter guarantees an argument at precisely the moment nobody has an appetite for one.

The leakage covenant and the indemnity

The SPA contains a covenant from the seller that there has been no leakage since the locked box date and that there will be none, other than permitted leakage, up to completion. It is backed by an indemnity requiring the seller to repay the leakage amount pound for pound, usually on a gross basis so that the buyer is left whole after tax.

This is a genuinely seller-friendly feature compared with a warranty claim. The buyer does not have to prove loss, quantify damages or show that the value of the shares was reduced. They point at the payment and ask for it back. That makes the claim easy for the buyer, which in turn is why sellers should insist on the limitations below.

Where there is a gap between signing and completion, the leakage covenant usually sits alongside conduct of business restrictions requiring the buyer’s consent for significant decisions such as large contracts, capital expenditure above a threshold, changes to employment terms and the disposal of assets. Both sides need to think about the practical reality of running a business under those restrictions for several weeks.

Interest, or value accrual, to the seller

If the buyer gets the profits from the locked box date but does not pay until completion, the seller has effectively given up the economic benefit of the business for that period while also waiting for the money. Sellers address this by negotiating an accrual on the price from the locked box date to completion.

There are two common approaches. An interest-based accrual, sometimes called a ticking fee, applies an agreed rate to the equity price for the number of days in the period, and is simple to calculate and hard to argue about. A cash-based accrual instead pays the seller an amount reflecting the cash the business actually generated in the period, which is more accurate but reintroduces exactly the sort of measurement exercise the locked box was supposed to avoid. For SME deals we would normally expect an interest-based accrual at a negotiated rate, because the simplicity is the point.

The accrual is negotiable and is routinely traded away. A buyer who is pushing hard on price will offer a locked box with no accrual, which is a real economic cost to the seller if the gap to completion is long.

Limits on leakage claims

Leakage protection is open-ended unless the agreement closes it down. The three limits a seller should always negotiate are a cap, a de minimis and a time limit.

• A cap, normally at the amount of the leakage itself rather than at the general warranty cap, so that leakage claims do not eat into the limits negotiated for everything else.
• A de minimis, so that a buyer cannot bring a claim over a trivial sum, with an aggregate threshold below which no claim can be brought at all.
• A time limit, typically six to twelve months from completion, which gives the buyer one full reporting cycle to spot anything and then closes the door.

The time limit matters more than it looks. Without one, the contractual default applies, and under section 5 of the Limitation Act 1980 an action founded on simple contract may be brought up to six years from the date the cause of action accrued. Where the SPA is executed as a deed, section 8 extends that to twelve years. Very few sellers intend to remain exposed to a leakage claim for six or twelve years, but that is the position if nobody shortens it.

Completion accounts and locked box side by side

The table below sets out the practical differences. The right-hand column is a generalisation about which side each point tends to suit in an owner-managed deal, and it is not a substitute for looking at the specific business.

A worked illustration

The figures below show the same deal priced both ways. They are illustrative only. They use round numbers, assume a straightforward capital structure and ignore tax, and they are not a prediction of how any particular transaction would price.

Who each mechanism favours, and why

The received wisdom is that a locked box favours sellers and completion accounts favour buyers. That is broadly right but too crude to be useful.

A locked box favours a seller because it delivers certainty. The number is known at signing, the full amount is received at completion, there is no retention held back against an adjustment, there is no three-month wait, and there are no accountants’ fees for a post-completion exercise. For a retiring owner who wants a clean break, those are not minor advantages.

Completion accounts favour a buyer because they pay for what they actually get. If the business has had a poor quarter, if debtors have gone bad, if stock has had to be written down, the price follows. A buyer using a locked box has none of that protection: they have bought the business as it stood on the locked box date and they carry whatever has happened since.

The crude version misses three things. First, a locked box only favours the seller if the locked box accounts are solid. If they overstate the business, the buyer will find it in diligence and reprice, and the seller has lost both time and credibility. Second, completion accounts can favour a seller where the business is growing, because a rising working capital balance increases the price. Third, a locked box exposes the seller to a leakage claim for whatever period the agreement allows, which is a residual liability that completion accounts do not create.

A separate point worth making, because we act for both sides: the mechanism is not a proxy for a good deal. We have seen sellers trade away a value accrual, a leakage cap and a de minimis in exchange for the word “locked box”, and end up worse off than they would have been with a well-drafted completion accounts schedule and a properly sized retention.

When a locked box genuinely suits an SME deal, and when it does not

This is the question most published guidance avoids, because the locked box grew up in private equity and auction processes where the conditions for it are usually present. In an owner-managed business they often are not. A locked box is only safe for a buyer if the balance sheet it is priced off can be relied on without a second look, and that is a high bar for a company that has never been audited.

A locked box tends to work in an SME deal where:

• There is a recent, properly prepared balance sheet, ideally a statutory year end, and preferably one that has been audited or at least independently reviewed.
• The buyer has had a genuine opportunity to diligence that balance sheet, including stock, work in progress and debtor provisioning, before signing.
• The gap between signing and completion is short and reasonably predictable, which usually means there are no lengthy regulatory or third party consents to obtain.
• The seller’s drawings are regular and quantifiable, so permitted leakage can be defined by formula rather than by argument.
• Trading is stable and not materially seasonal, so the business between the locked box date and completion does not look materially different from the business priced.
• There is a single seller, or a small and cooperative group, so that the leakage covenant and indemnity sit with people who can actually meet a claim.

It tends not to work where:

• The only numbers available at the locked box date are management accounts that have never been prepared to a consistent standard, which is the position in a large number of owner-managed companies.
• Stock or work in progress is a significant part of the balance sheet and has only ever been estimated rather than counted.
• Completion depends on a consent with no reliable timetable, such as a landlord’s licence to assign, a regulatory registration or a contract novation, so the gap could stretch to months.
• The business is genuinely seasonal, so the locked box date position tells you little about the position at completion.
• The seller’s drawings are irregular, mixing salary, dividends, loan account movements and expenses, so there is no clean basis for defining permitted leakage.
• The seller will not remain good for a leakage claim after completion, for example where the proceeds will be distributed across several shareholders and immediately spent.

There is also a middle route that is underused in SME deals. You can price off a locked box but require a specific, limited confirmation of one or two balance sheet items at completion, such as a physical stock count, with a narrow adjustment for that item alone. It gives the buyer protection where their risk genuinely sits, without reopening the whole price. Buyers who refuse a locked box outright are often really objecting to one line of the balance sheet, and that is worth establishing before abandoning the mechanism.

Whichever way the deal goes, the mechanism needs to be settled in the heads of terms, not discovered during drafting. A buyer who agrees heads of terms silent on pricing mechanism has reserved the right to propose completion accounts later, and a seller who assumed a locked box has lost an argument they never knew they were having. We cover this sequencing in our guide to selling a business and our guide to buying a business.

The practical questions that decide the choice

In our experience the mechanism settles itself once the parties answer the following honestly. The answers also tell you what the schedule needs to say.

1. How good are the accounts at the proposed locked box date, really? If the answer involves the word “roughly”, the locked box is on shaky ground and a buyer will find out in diligence.
2. How long is the gap between signing and completion, and what controls it? A same-day signing and completion removes much of the argument. A three-month gap waiting on a third party consent does the opposite.
3. Which two or three balance sheet lines actually move the price in this business? Name them. Under completion accounts they become specific accounting policies. Under a locked box they become the focus of diligence.
4. How does the seller take money out of the company, month by month? This decides whether permitted leakage can be written as a formula or will be a running argument.
5. What is the seller’s tolerance for waiting and for a clawback? A retiring owner funding a house purchase on completion day has a different answer from a seller rolling over into the buyer’s group.
6. Will the seller be good for a claim after completion? This shapes the retention under completion accounts and the leakage limits under a locked box, and it is the question buyers should ask first.
7. Who prepares the numbers, and on what basis? Under completion accounts, this is the single most valuable thing to negotiate and the most commonly conceded.
8. What happens if you cannot agree? Decide now who the expert is, what they may and may not decide, how long they have, and who pays.

A buyer running a structured process will usually have views on all of this before the seller does, which is one of the reasons buyers tend to do well out of the pricing mechanism. Preparing the answers early, as part of preparing the business for sale, is one of the cheapest pieces of value protection available to a seller. The same applies in reverse on the buy side, where the pricing mechanism should be scoped alongside legal due diligence rather than after it.

Two things that catch SME parties out

A pre-completion dividend still has to be lawful

Sellers frequently plan to strip surplus cash out by dividend before completion, and both mechanisms accommodate that if it is handled properly. What is sometimes forgotten is that company law applies regardless of what the share purchase agreement permits. Under section 830 of the Companies Act 2006, a company may only make a distribution out of profits available for the purpose, which are its accumulated realised profits less its accumulated realised losses. Section 836 then provides that whether a distribution may be made without contravening Part 23 is determined by reference to the items as stated in the relevant accounts.

In practice that means an interim dividend declared in the run-up to completion needs to be justified by accounts that actually support it, properly minuted, and documented at the time rather than reconstructed afterwards. An unlawful distribution can be recoverable from the shareholder who received it and can expose the directors who approved it. A buyer’s diligence will look at this, and a buyer who finds a sloppy pre-completion dividend will want a specific indemnity for it, which is a worse outcome for the seller than doing it properly in the first place.

Stamp duty is affected by which mechanism you choose

Stamp duty on a transfer of shares in a UK company is charged at 0.5% of the chargeable consideration, rounded up to the nearest £5 on each document, and is payable where the consideration exceeds £1,000. HMRC require the stock transfer form to be sent to them and the duty to be paid within 30 days of the form being signed and dated.

A locked box produces a fixed figure, so the duty is calculated and paid on a known number within the 30 day window with nothing further to do. A completion accounts deal does not. Where the consideration is calculated by reference to another document such as the share purchase agreement, HMRC’s guidance is that this must be stated on the stock transfer form and a copy of the agreement submitted with it. If the final price turns out lower than the amount on which duty was paid, a refund has to be claimed, and HMRC require refund claims to be made within two years of the date of the stamped document.

None of this will decide the mechanism, but it is a real administrative difference, and it is the buyer’s problem rather than the seller’s since the buyer pays the duty. It is worth raising early so that the stamping position is planned rather than improvised. The tax treatment of the price for the seller is a separate matter: section 48 of the Taxation of Chargeable Gains Act 1992 requires consideration to be brought into account without any discount for postponement of the right to receive it, which makes the timing of a true-up or an accrual something to work through with your accountant before signing, not after. We set out the legal position only, and the tax treatment of any particular deal should be confirmed with your accountant or tax adviser.

What this means for your deal

Completion accounts buy accuracy at the cost of time, professional fees and the risk of a dispute. A locked box buys certainty and a clean completion at the cost of relying on a historic balance sheet. For most owner-managed UK businesses completion accounts remain the realistic default, simply because the quality of historic management information is not good enough to support a fixed price. Where a company does have a reliable, recent, properly prepared balance sheet and a short, predictable path to completion, a locked box is available and can be the better deal for a seller, provided the accrual, the permitted leakage definition and the leakage limits are all negotiated rather than accepted as drafted.

Either way, the mechanism should be agreed in the heads of terms, drafted in a schedule that names the specific accounting judgments in your business, and tested against the question of what happens if the two sides disagree. Those three things do more to protect the price than almost anything else in the document, and they are routinely left until the fortnight before completion when there is no time to argue. If you want a wider view of how the pricing mechanism sits alongside the rest of the transaction, our overview of corporate legal services and our note on what affects the price of a practice sale are useful starting points, and the same principles apply to management buy-outs and buy-ins where the incoming team is often negotiating both sides of the table at once.

If you are negotiating a business sale or purchase and want the pricing mechanism looked at properly before you sign heads of terms, we would be glad to talk it through. We act for both buyers and sellers, so we see where each mechanism goes wrong from both directions. Speak to our team about selling a business or buying a business, call us on +44 207 566 1188, or email info@gurvelegal.com.