Completion Accounts

Completion accounts are a set of accounts for a target company or business, prepared shortly after its sale has completed and made up to the completion date. They are used to calculate the final purchase price. The buyer pays an estimated price at completion; once the completion accounts are agreed, the price is adjusted up or down to reflect the financial position the business actually had on the day ownership changed.

They are one of the two main pricing mechanisms in private mergers and acquisitions. The alternative is the locked box mechanism, under which the price is fixed by reference to a balance sheet drawn up before signing and is not adjusted afterwards. In the United States, the completion accounts approach is the norm and is usually called a closing accounts or post-closing purchase price adjustment.

Buyers normally value a business on a cash-free, debt-free basis and assume that it will be delivered with a normal level of working capital. The headline figure agreed between the parties is this enterprise value. The amount actually payable for the shares, the equity value, depends on how much cash and debt the company holds and on whether its working capital is above or below normal on the completion date.

Those figures cannot be known precisely in advance, because the business continues to trade until completion. Completion accounts supply them. The usual adjustments are:

• Cash. The price is increased by cash in the business at completion.
• Debt. The price is reduced by borrowings and debt-like items; see net debt adjustment.
• Working capital. The price is increased or reduced by the difference between actual working capital and an agreed target, sometimes called the peg; see working capital adjustment.

Some deals instead adjust for net assets as a whole.

The sale agreement sets out the procedure in detail. Before completion, the seller provides an estimate of the relevant figures, and the buyer pays the price based on it. After completion, one party, usually the buyer because it now controls the books, prepares draft completion accounts within a fixed period, often 30 to 60 days. The other party has a similar period to review them, with access to the records and working papers, and either accepts them or serves a notice setting out the items it disputes.

The parties then try to settle any differences by negotiation. Items that remain in dispute are referred to an independent accountant, who acts as an expert and not as an arbitrator, and whose decision is final except in cases of obvious error. Once the accounts are settled, the balancing payment is made within a few days. Part of the price may be held in an escrow holdback at completion to secure any payment due from the seller.

Most disputes turn on how items should be measured, so the agreement specifies a hierarchy of accounting policies. Specific policies written into the agreement come first. Next come the policies, practices and judgements applied in the target's last audited accounts, applied consistently. Last come the relevant accounting standards. The order matters: a buyer may wish to apply accounting standards strictly, for example by increasing provisions, while the seller will argue for consistency with past practice.

Well-drafted agreements also define which balance sheet lines count as cash, debt or working capital. Items that commonly cause argument include deferred income, accrued bonuses, tax liabilities, finance leases, pension deficits, overdue creditors and cash that is trapped or needed for regulatory purposes. The treatment of events after the completion date, and the cut-off date for taking new information into account, should be stated as well.

Completion accounts allocate risk differently from a locked box. The seller keeps the economic risk and reward of the business up to completion, and the price reflects exactly what is delivered. This suits a buyer, and it suits situations in which no reliable recent balance sheet exists, such as the carve-out of a division from a larger group, or in which there is a long gap between signing and completion.

The cost is uncertainty and effort. Neither side knows the final price until months after completion, the process consumes management time and advisers' fees, and it creates scope for disagreement at a moment when the parties may need to cooperate. A locked box gives price certainty and a cleaner exit, which is why sellers, particularly private equity funds that need to distribute proceeds promptly, tend to prefer it. Under a locked box, the buyer relies on thorough due diligence on the reference balance sheet and on the seller's promise that no value has leaked out since.

The completion accounts adjustment is separate from other mechanisms that can change what a seller receives. An earn-out makes part of the price depend on the performance of the business after completion. Warranty and indemnity claims compensate the buyer for breaches of the seller's contractual statements; agreements usually prevent the buyer from recovering twice for a matter already reflected in the completion accounts. The same mechanics apply whether the buyer is a trade purchaser or a management team in a management buyout, and the starting point in each case is the target's most recent balance sheet.