A seller agrees a price of £2.4m and spends the evening doing sums with it. Three months later a document arrives showing that what will actually be paid is £2.34m, or £2.46m, or something else again — and the buyer has not moved on price at all. Nobody has done anything underhand. The number agreed at heads of terms was an enterprise value, and enterprise value is not money.
The gap between the two is closed by a price mechanism, and there are only two of them in common use. Which one you are on, and how its inputs are set, routinely moves six figures on a professional-services deal. It is also decided early, in a document most sellers skim, at the exact moment they are least inclined to argue about accounting.
Almost every deal is struck on a cash-free, debt-free basis. That phrase means the price values the business as a trading operation, ignoring how it happens to be financed. The seller keeps the cash and clears the debt, and the arithmetic to get from one to the other is the bridge:
The first three lines are usually uncontroversial once the definitions are settled. The fourth is where deals move, because “normal” is a negotiated opinion dressed as a calculation.
Under a completion accounts mechanism, the parties complete on an estimate and then work out the real figure afterwards. A set of accounts is drawn up as at the completion date, the bridge is recalculated on actual numbers, and the difference is paid one way or the other.
Three features matter to a seller. The buyer normally prepares the draft, which means the first version of the truth is written by the person who benefits from a low number. There is a review window — commonly thirty to forty-five days — in which you must respond, and it is short. And unresolved items go to an independent expert whose determination is final, which is fast and cheap compared with litigation but gives you no appeal.
The advantage is that you keep the value you generate right up to completion. If you have a strong final quarter, you are paid for it.
A locked box works from a historic balance sheet, typically the last audited or fully prepared accounts. The equity price is calculated from those figures and fixed at signing. Economic risk and reward pass to the buyer from that locked box date, even though legal ownership passes later.
Nothing is recalculated afterwards. Instead, the seller covenants that no value has leaked out of the company since the locked box date, and repays any that has, pound for pound.
Leakage means dividends, bonuses and salary rises to the sellers, repayment of directors' loans, personal expenses, assets transferred out, and management charges to connected companies. Permitted leakage is the agreed list of things you are still allowed to do — ordinary salary, a pre-agreed dividend, contracted bonuses. Getting that list complete is the single most valuable drafting job a seller's solicitor does on a locked box deal, because anything missing from it is repayable in full.
Two further points. Because the buyer owns the economics from the locked box date, sellers often negotiate an interest charge — a “ticker” — on the price for the period between that date and completion. And the older the locked box date, the more profit you are handing over for nothing, so a locked box date eight months in the past is a real cost, not a technicality.
Illustrative figures, constructed to show the mechanism. Not drawn from any particular transaction.
A practice is agreed at an enterprise value of £2.4m, cash-free and debt-free. At completion it holds £180,000 of cash and £60,000 of remaining term debt. Actual working capital — principally unbilled work and trade debtors, less creditors and deferred income — is £250,000.
Everything now depends on the target. Take two versions, both defensible, both produced from the same set of accounts.
| Target set on a 12-month average | Target set on the three months after filing season | |
|---|---|---|
| Enterprise value | £2,400,000 | £2,400,000 |
| Add: cash | £180,000 | £180,000 |
| Less: debt | (£60,000) | (£60,000) |
| Working capital target | £310,000 | £430,000 |
| Actual working capital | £250,000 | £250,000 |
| Working capital adjustment | (£60,000) | (£180,000) |
| Equity value | £2,460,000 | £2,340,000 |
The difference is £120,000, and no one has renegotiated the price. The entire swing comes from which months were used to define what normal looks like — and in a practice with a filing season, the seasonal spread of debtors and unbilled work is enormous.
This is why a seller needs their own working capital analysis before the target is discussed, ideally covering a full twelve-month cycle with the seasonal pattern set out plainly. It is a day of work that arrives before the negotiation rather than after it.
Four things behave differently in a fee-based business than in the manufacturing examples most guidance is written around.
Unbilled work is the biggest number and the softest. Whether it counts as working capital, and at what recoverability percentage, can move the adjustment more than everything else combined. Settle the definition, not just the target.
Debtors carry an ageing question. Buyers commonly want anything over ninety days excluded from working capital or covered by a specific indemnity. That can be reasonable, but only if the same test was applied to the accounts the target was built from.
Deferred income is a genuine liability. Fees billed in advance for work not yet done are a real obligation the buyer will have to discharge, and they belong in the calculation. Sellers who bill annually in advance should expect this and should not be surprised by it.
Debt-like items are broader than debt. Accrued holiday pay, unpaid PAYE and VAT, dilapidations on the lease, and any overdrawn directors' loan are all candidates for the debt line. The list is negotiated, and it is much easier to argue about at heads of terms than in week six of legals. Our note on heads of terms and exclusivity covers why that document deserves more attention than it usually gets.
It depends on which risk you would rather carry.
A locked box gives you price certainty from signing, a cleaner completion, and no post-deal accounting process to argue through. It suits a retiring seller who wants a known number and a clean break. The price is that you hand over the profits earned after the locked box date unless you have negotiated interest, and you carry an absolute repayment obligation on leakage.
Completion accounts keep you economically in the business until the day you leave, so strong recent trading is paid for. The price is uncertainty for a couple of months after completion, a short review window, and a first draft written by the buyer.
The practical answer for most professional-services sellers is that the mechanism matters less than the inputs. A well-negotiated completion accounts deal beats a badly-drafted locked box, and the reverse is equally true. What loses money is accepting either without having looked at the definitions.
Every one of those is easier to secure while the buyer still wants the deal than after exclusivity has been granted. That is the general rule of a sale process, and it applies more sharply here than almost anywhere else, because none of these points look like price until they are.
Our notes on where the price gets chipped in due diligence and warranties and the disclosure letter cover the stages either side of this one, and preparing your firm for sale is where the working capital analysis should properly begin.
The transaction figures in this article are illustrative and are not drawn from any particular deal. This article is general information about how price mechanisms operate on a professional-services transaction, not legal, tax or investment advice, and Founder Capital LLP is not authorised or regulated by the Financial Conduct Authority. Nothing here is an offer or invitation to invest; any investment opportunities we reference are available only to professional investors, certified high-net-worth individuals and self-certified sophisticated investors, are not open to retail investors, and capital is at risk and returns are not guaranteed. Please take specific advice from a qualified corporate finance adviser and solicitor before you sign anything.
Enterprise value is what the business is worth as a trading operation, independent of how it happens to be financed. Equity value is what the shareholders actually receive. You get from one to the other across what is called the bridge: add the cash in the company, deduct the debt and anything debt-like, then adjust for whether working capital at completion is above or below an agreed normal level. A practice agreed at an enterprise value of £2.4m with £180,000 of cash, £60,000 of debt and a £60,000 working capital shortfall produces an equity value of £2.46m. The headline number and the money are two different figures, and only one of them gets paid.
Neither is inherently better, but they distribute risk very differently. A locked box fixes the balance sheet at a historic date, so the price is certain from signing and you cannot be surprised afterwards, but you give up any profit earned between that date and completion unless interest is negotiated. Completion accounts measure the position on the actual day, so you keep the value you generate right up to the finish line, but the final number is not known until several weeks after you have handed over the keys and it is prepared by the buyer. Sellers who value certainty prefer a locked box. Sellers with strong recent trading often do better on completion accounts.
Leakage is value that comes out of the company for the sellers' benefit between the locked box date and completion, and it is repaid pound for pound. Dividends, above-market salary increases, bonuses to the sellers, repayment of directors' loans, personal expenses run through the company and assets transferred out all count. Because the buyer is economically the owner from the locked box date onwards, anything you take after it is money you have effectively taken from them. The counterpart is permitted leakage, an agreed list of payments you are allowed to make, such as ordinary salary and pre-agreed dividends, and getting that list right and complete is the single most important piece of drafting for a seller in a locked box deal.
Because the working capital of an accountancy or legal firm swings enormously through the year and almost all of it is unbilled work and debtors rather than stock. A firm that measures its normal level using the months after a filing season will set a target far above the level in a quiet quarter, and any shortfall against that target is deducted from the price pound for pound. The same firm, using a twelve-month average across a full cycle, can produce a target well over £100,000 lower on an identical business. The target is negotiated, not calculated, and sellers who arrive without their own analysis accept whichever version the buyer's adviser has prepared.
Far earlier than most sellers realise, usually in the heads of terms rather than in the share purchase agreement. By the time the lawyers are drafting, the choice between locked box and completion accounts and the broad approach to the working capital target have normally been agreed in principle, and reopening either looks like renegotiation. That is why the mechanism deserves attention at the point where sellers are least inclined to give it any, which is when the headline price has just been agreed and the deal finally feels real. Ask what the mechanism is, and what the target will be built from, before you grant exclusivity.
