You've agreed a price for your company. Then the draft sale agreement arrives with a page of definitions and a formula, and the amount you'll receive turns out to depend on a balance sheet that may not have been drawn up yet.
That formula is the price adjustment. It deals with the cash in the company and the money it owes, and checks that you leave enough working capital behind. There are two main ways of doing it, completion accounts and the locked box. This guide explains both, with a made-up example of each, and what to agree before the lawyers start drafting.
Why the price gets adjusted
Buyers usually value the business itself, mostly on its profit. Our guide to how to value a business explains how. That gives a price for the business as if it had no cash and no debt, often described as cash-free and debt-free. The price for your shares then adds the cash in the company and takes off what it owes, such as bank loans and finance agreements.
Working capital is the third part. It's the money tied up in day to day trading, mainly stock and what customers owe you, less what you owe suppliers. A buyer expects a normal level to be left in the business, because otherwise a seller could boost the cash before completion by chasing every customer and paying no suppliers. The normal level, sometimes called the target or the peg, is often worked out from an average of recent months, so seasonal swings even out.
So the price for the shares is the value of the business, plus cash, less debt, adjusted for any difference between the actual and the normal working capital. The two methods differ in when those figures are measured, and who carries the risk in between.
Completion accounts
With completion accounts, the figures are measured on the day the company changes hands. On completion the buyer pays a price based on an estimate, and part of it may be held back. After completion one side, often the buyer because it now runs the company, draws up a balance sheet as at completion. The other side has a set period to review it and raise objections.
Once the completion accounts are agreed, the price is trued up and whichever side is out of pocket is paid the difference. If you can't agree, the sale agreement normally sends the dispute to an independent accountant acting as an expert. The ICAEW lists completion accounts among the things an expert is typically appointed to decide, and notes that the parties need to agree to be bound by the decision.
The agreement has to say how the accounts are prepared, including which accounting policies apply and which wins if they conflict. Much of the negotiation is in that detail, because small choices about how stock or income received in advance is treated can move the price.
A made-up example of completion accounts
A buyer agrees to pay £2,000,000 for a business on a cash-free, debt-free basis, with normal working capital of £150,000. When the completion accounts are agreed, they show the company had £180,000 of cash, a bank loan of £100,000 and working capital of £120,000.
| Made-up example | Amount |
|---|---|
| Agreed value of the business | £2,000,000 |
| Add the cash in the company | £180,000 |
| Take off the bank loan | £100,000 |
| Take off the working capital shortfall (£150,000 normal, £120,000 actual) | £30,000 |
| Final price for the shares | £2,050,000 |
If the buyer paid £2,080,000 on completion, based on the estimate, you'd repay £30,000. If it paid £2,000,000, it would pay you a further £50,000. Any cash the business made before completion is counted, so the profit up to that day is yours.
The locked box
With a locked box, the figures are measured earlier. The price for the shares is worked out from a balance sheet at an earlier date (the locked box date) and written into the sale agreement as a fixed figure. That balance sheet may be the last year end accounts or accounts drawn up specially. There's no adjustment after completion.
From the locked box date, the business is treated as being run for the buyer. You promise that no value will leave the company for your benefit between that date and completion. Value that does leave is called leakage. Typical examples are these.
- Dividends and other payments to shareholders.
- Bonuses or fees paid to you or your family beyond what's agreed.
- The company paying your personal bills, or your costs of selling.
- Money you owe the company being written off.
The agreement lists permitted leakage, which is allowed. That usually means things like your normal salary and pension contributions, and any payment already priced in. Anything else must be repaid to the buyer pound for pound, usually under an indemnity with a time limit for claims. You'll also warrant that the locked box accounts are accurate and that nothing has leaked up to signing.
Because the business is run for the buyer from the locked box date, the profit it makes from then on goes to the buyer too. Sellers often negotiate a payment for that period. It's sometimes called a ticker or a ticking fee, and it's a daily or monthly amount added to the price until completion.
A made-up example of a locked box
The locked box accounts are drawn up at 31 March 2027. They show £200,000 of cash, a bank loan of £50,000 and working capital at the normal level. With the business valued at £2,000,000, the price for the shares is fixed at £2,150,000. The sale completes on 30 June 2027, with a ticker of £10,000 for each month after the locked box date. In May the owner takes a £40,000 dividend that isn't on the permitted list.
| Made-up example | Amount |
|---|---|
| Fixed price from the locked box accounts | £2,150,000 |
| Add the ticker for April, May and June | £30,000 |
| Take off the leakage (the dividend) | £40,000 |
| Amount received for the shares | £2,140,000 |
Without the ticker, the owner would have received £2,110,000, and the three months of profit after the locked box date would have gone to the buyer for nothing. Counting the dividend, the owner still ends up with £2,180,000 in total, so taking it added nothing. It came back off the price, pound for pound.
Which suits a small owner-run business
A locked box tends to suit a steady business with reliable, recent accounts. You know the price when you sign, and there's no second negotiation over a balance sheet after completion. Lenders often prefer the certainty too, which can help a buyer that's borrowing.
Completion accounts tend to suit a business whose working capital swings a lot, perhaps because it's seasonal or works on large projects. They also suit a business whose accounts a buyer can't rely on, or a sale with a long gap between signing and completion. The cost is uncertainty about the final price, and the risk of a dispute after you've handed over the keys.
The locked box needs good figures to work from. If your year end accounts are months old by the time a buyer is ready to sign, you may need accounts drawn up specially. Monthly management accounts that tie back to the year end make either method easier, and help set a fair normal working capital.
Taking cash out before the sale
If you'd like to take surplus cash out of the company before selling, remember that a company can only pay dividends out of profits available for the purpose. Check with your accountant that there are enough. With a locked box, pay any dividend before the locked box date or list it as permitted leakage, allowed for in the price. With completion accounts, cash you take out lowers the price by the same amount.
Either way, the total you receive is broadly the same. What changes is how it's taxed, so ask your accountant which suits you before you take anything out.
What to agree early
The method usually goes in the heads of terms, and the detail in the share purchase agreement. Most disputes come from definitions that seemed obvious at the time. Agree these as early as you can.
- What counts as cash, including customer deposits and cash that can't be spent freely.
- What counts as debt, such as overdue tax, finance agreements and loans from you.
- How normal working capital is worked out, and over which months.
- For completion accounts, who prepares them, the timetable and who pays for an expert.
- For a locked box, the date, the permitted leakage list and any ticker.
- How much of the price is held back, and when it's released.