Definition
A locked box fixes the price by reference to a balance sheet at a date before the deal is signed, called the locked box date, after which the business's value is treated as belonging to the buyer. The seller promises that no value will leave the business before completion, through dividends, bonuses, management charges or payments to related parties, except for items the parties agree in advance. There is no price adjustment after completion. Locked boxes are common in the UK and Europe and less so in US deals.
Worked example
Moonpenny Bakeries GmbH is a fictional German business sold for €3,000,000, based on accounts at 31 March. The sale completes on 30 June.
In April the seller pays herself a €100,000 bonus that was not on the agreed list of permitted payments. That is leakage, so the buyer can recover the €100,000 from the seller under the purchase agreement.
Why buyers care
A locked box gives both sides price certainty and avoids arguments over completion accounts. The trade-off is that you carry the risk of the business trading poorly between the locked box date and completion, and you rely heavily on the locked box accounts being right.
Test those accounts thoroughly in due diligence, and prefer a recent locked box date. Make sure leakage is defined widely, that permitted payments are listed precisely, and that the seller's promise can actually be enforced. Sellers sometimes ask for a daily sum for the period between the locked box date and completion, reflecting profits earned in that time. Take advice from your lawyer and accountant on whether a locked box suits the deal.
Completion accounts are a balance sheet drawn up at the date a sale completes, used to adjust the price for the actual cash, debt and working capital the buyer receives.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.