Locked Box vs. Working Capital Adjustment

The choice of pricing mechanism is one of the most relevant structural decisions in a merger and acquisition transaction. The two predominant models—locked box pricing and completion accounts—allocate economic risk differently between buyer and seller and have significant practical effects on negotiation, execution, and post-closing relationships.

Synthesis of the Mechanisms

Completion accounts. In what is called working capital adjustment, the price is fixed, in an estimated form, at signing and adjusted, after closing, based on the company's actual financial position on the closing date. The parties agree on a benchmark level of working capital, and the price rises or falls according to the actual result. The final settlement involves the preparation of closing accounts, review by the counterparty, and often, dispute resolution by an independent accounting expert.

Locked box. In a locked box, the price is fixed at signing based on a historical balance sheet (reference date). From then on, the seller commits to not extracting value from the company—dividends, management fees, and transactions with unauthorized related parties (non-permitted leakage) are prohibited. In theory, the price should include a kicker for the period between the reference date and closing, compensating the seller for the time they remained in management of the business and for any potential appreciation in value.

Practical Effects

Fixed Price. The locked box offers a fixed and definitive price from the moment of signing. This can be convenient for sellers, as they seek third-party resources to finance the operation. The working capital adjustment keeps the price open during the post-closing review period, with a real risk of accounting disputes.

Allocation of economic risk. In a locked box, the economic risk of the business is transferred to the buyer at the reference date: increases in value benefit the buyer; decreases harm the buyer. In working capital adjustment, the economic risk extends until closing, with the adjustment mechanism acting as partial protection against short-term variations.

Complexity after closing. The locked box terminates the financial relationship between the parties at closing. Working capital adjustments prolong this interaction, with the risk of litigation over accounting issues, which is relatively frequent in M&A transactions involving significant price variations.

Specifics of the Brazilian Market

Market practice. Working capital adjustment still predominates in Brazil, a legacy of North American influence on local practice. The locked box, however, has gained significant ground in the last decade, driven by European buyers and funds that have adopted it as a standard.

Importance of financial statements. The locked box depends entirely on the accuracy of the benchmark balance sheet. In Brazil, privately held companies and family groups often maintain accounting that mixes tax criteria with IFRS or BR GAAP, generating ambiguities that increase risk for the buyer.

Interest on Equity (JCP). JCP is a tax-efficient form of remuneration widely used by shareholders in Brazil. In locked-box operations, it must be expressly addressed in the permitted leakage schedule—its omission is one of the main sources of disputes in the local market.

Regulatory deadlines. The CADE's post-signature notification system (up to 240 business days in complex cases) and approvals in regulated sectors (BACEN, SUSEP, ANEEL, ANATEL) create long intervals between signing and closing, making the clear allocation of economic risk during this period—regardless of the mechanism chosen—a practical necessity, not just a contractual precaution. Furthermore, care must be taken to ensure that any limitations imposed on the seller in managing the business do not constitute gun-jumping, i.e., the consummation of the transaction and the imposition of anti-competitive effects before CADE approves the operation.

Final Considerations

There is no universally superior mechanism: the choice depends on the profile of the parties, the quality of available financial information, the sector, and the expected timeframe between signing and closing. In Brazil, the parties must assess, in each transaction, the local specificities—especially the corporate structure of the target company, the treatment of interest on equity, and regulatory deadlines—to recommend the most appropriate mechanism and structure it precisely. Strictly speaking, the choice of one mechanism or another will depend on the bargaining power of each party.

Article written by: Antonio Mazzucco.