A letter of intent quotes one number, usually an enterprise value: what the buyer will pay for the business with no cash and no debt, carrying a normal level of working capital. The seller never receives that number. What changes hands at closing is the equity purchase price, which is the enterprise value adjusted for the cash, debt, debt like items and working capital the business actually has on the day the deal closes. The gap between the two can be tens of millions of dollars, and most of it is negotiated after the headline has been agreed.
There are two ways to fix that equity price. Under completion accounts, common in US deals, the parties estimate the adjustments at closing and true them up against a final closing balance sheet a few months later. Under a locked box, common in European sponsor deals and increasingly seen in competitive US auctions, the price is fixed off a historical balance sheet and the seller promises that no value has left the business since that date.
This topic walks through the bridge from enterprise value to equity value, the definitions that carry most of the money (cash, debt, debt like items and net working capital), how a working capital peg is set from a trailing average, a full closing statement with a post closing adjustment, and the locked box with its leakage protection and ticker.
Key takeaways
- A cash free, debt free price means the seller keeps the value of cash and bears the cost of debt: equity price equals enterprise value plus cash, less debt and debt like items, plus or minus the working capital adjustment.
- The definitions in the purchase agreement, not the accounting labels, decide what counts as cash, debt and working capital; debt like items such as unpaid bonuses, pre closing taxes and seller deal fees are where value moves.
- The working capital peg is the normal level of working capital the price assumes, usually set from a trailing twelve month average so that seasonality cannot be gamed in either direction.
- Completion accounts use an estimate at closing and a true up afterwards, typically secured by an adjustment escrow; in the Halden example the estimate of $330.0m becomes a final $327.4m and the seller repays $2.6m.
- A locked box fixes the price off a historical balance sheet, protects the buyer with a covenant against leakage repaid dollar for dollar, and compensates the seller for the cash the business earns before closing through a ticker.
From headline enterprise value to equity purchase price
Buyers price businesses on earnings, and earnings are produced by the operating business regardless of how it is financed. So bids are made on enterprise value, usually a multiple of adjusted EBITDA, on a cash free, debt free basis. The phrase means the buyer is paying for the operations alone. If the business holds cash at closing, the seller is paid for it; if it owes debt, the debt is repaid out of the price, so the seller effectively bears it.
The bridge from enterprise value to the equity purchase price has four moving parts: cash, which is added; funded debt, which is subtracted; debt like items, which are subtracted because they are claims that will be paid with the buyer's money after closing; and the working capital adjustment, which adds or subtracts the amount by which actual working capital at closing differs from the normal level the price assumed.
Each of these is a defined term in the purchase agreement, and the definitions are drafted line by line. A buyer that agrees a headline multiple and then loses the definitions has agreed a lower multiple than it thinks. A seller's adviser knows this, which is why the closing mechanics are negotiated by the same people who negotiated the price.
- Enterprise value
- The headline price for the business on a cash free, debt free basis with a normal level of working capital.
- Cash
- Cash and cash equivalents as defined in the agreement, usually excluding trapped or restricted cash and outstanding checks.
- Funded debt
- Borrowings, accrued interest, and any prepayment premium or breakage cost triggered by repaying them at closing.
- Debt like items
- Other obligations that arose before closing and will be paid by the business after it: unpaid deal bonuses, pre closing income taxes, unpaid seller transaction expenses, deferred compensation.
- Working capital peg
- The normal level of net working capital assumed in the enterprise value, also called the target.
Cash, debt and debt like items
Cash is not simply the bank balance. Agreements usually exclude cash that cannot be freely used, such as customer deposits held in trust, cash collateral behind letters of credit, or cash in a foreign subsidiary that cannot be repatriated without tax. They deduct checks written but not cleared. Some buyers also cap the cash they will pay for, so that a seller cannot hoard receivables collections into a large closing cash balance at the expense of the working capital adjustment.
Funded debt includes every borrowing that will be repaid at closing, with its accrued interest, and any cost of repaying it early. A term loan with a 1 percent prepayment premium costs 101 to repay, and the extra point belongs in debt. Capital leases and interest rate swap breakage costs are usually included as well.
Debt like items are where diligence earns its fee. The test is whether an obligation relates to the period the seller owned the business, is not part of normal working capital, and will cost the buyer cash after closing. Unpaid sale bonuses, income taxes for pre closing periods, seller deal fees not paid at closing, deferred compensation, unfunded pension obligations, declared but unpaid dividends and deferred purchase price from past acquisitions are the usual candidates. Deferred revenue and accrued capex are contested: sellers argue they are working capital, buyers argue they are claims on future cash. The quality of earnings report is normally the buyer's source list.
A dollar of item moved from working capital into debt like items is worth a dollar to the buyer only once, so the agreement must make sure nothing is counted twice. A pre closing tax liability cannot sit in both the working capital definition and the debt definition.
| Item | Usual treatment | Who argues otherwise |
|---|---|---|
| Unrestricted cash | Added as cash | Buyer may seek a cap |
| Trapped or restricted cash | Excluded | Seller |
| Term loans, revolver, accrued interest | Funded debt | Rarely contested |
| Prepayment premiums and swap breakage | Funded debt | Seller, if the buyer chose to refinance |
| Unpaid transaction bonuses and seller deal fees | Debt like item | Rarely contested |
| Pre closing income taxes | Debt like item | Seller, on timing and estimates |
| Deferred revenue | Negotiated: working capital or debt like | Both, depending on cost to deliver |
| Accrued but unpaid capex | Negotiated | Seller |
| Trade payables and receivables, inventory | Net working capital | Rarely contested |
Setting the working capital peg
Net working capital for this purpose is usually defined as current operating assets less current operating liabilities: receivables, inventory and prepaid expenses, less payables and accrued expenses, with cash, debt, income taxes and anything already treated as debt like stripped out. The definition is tied to a set of accounting principles, normally the company's historical practice consistently applied, and often to an illustrative calculation attached to the agreement.
The peg is the level of that working capital the business needs to run normally. Without a peg, a seller could collect receivables aggressively, run down inventory and stretch payables in the months before closing, turning working capital into cash that it is then paid for, and leave the buyer to refill the business. With a peg, every dollar taken out of working capital comes back off the price.
The usual starting point is the trailing twelve month average of month end working capital. An average of twelve months captures a full seasonal cycle, so neither side can argue for the peak or the trough. Adjustments follow: if the business is growing fast, a buyer may argue for a higher peg or the last six months; if a one off event inflated a month, it may be normalised out. Some agreements add a collar, a small band around the peg within which no adjustment is made, to save arguing over immaterial amounts.
- NWC month n
- Month end net working capital as defined in the agreement, for each of the last twelve months.
| Month | NWC | Month | NWC |
|---|---|---|---|
| Month 1 | 56.8 | Month 7 | 59.2 |
| Month 2 | 58.2 | Month 8 | 57.6 |
| Month 3 | 61.4 | Month 9 | 59.4 |
| Month 4 | 63.9 | Month 10 | 61.8 |
| Month 5 | 63.1 | Month 11 | 60.5 |
| Month 6 | 60.7 | Month 12 | 57.4 |
A full closing statement and the true up
Under completion accounts, the seller delivers an estimated closing statement a few days before closing, and the buyer pays the estimated equity price. Within a set period after closing, often 60 to 120 days, the buyer prepares the final closing statement from the actual closing balance sheet. The seller can dispute it within a review window; unresolved items go to an independent accountant, who decides only the disputed items, within the range of the two sides' positions.
The difference between the final and estimated price is paid by whichever side owes it. Buyers usually hold back an adjustment escrow at closing, sized as a small percentage of the price, so that a shortfall can be recovered without chasing the seller. Some agreements make the adjustment escrow the buyer's only recourse for a downward adjustment, which is one reason sellers push for it to be small and buyers for it to be adequate.
Halden Packaging: estimated and final closing statements
- Halden Packaging, a hypothetical maker of specialty packaging, is sold for an enterprise value of $500.0m (10.0x adjusted EBITDA of $50.0m) on a cash free, debt free basis. Peg $60.0m.
- Estimate at closing: cash $20.0m after excluding $2.0m of trapped cash; term loan $160.0m, revolver $15.0m, accrued interest $1.2m, prepayment premium $0.8m; debt like items of unpaid deal bonuses $3.0m, pre closing income taxes $4.5m, unpaid seller deal fees $2.5m and deferred compensation $1.0m; estimated closing NWC $58.0m.
- Final statement 90 days later: cash $19.4m; an extra $0.6m of accrued bonuses found, so debt like items $11.6m; closing NWC $56.6m. Debt unchanged. Adjustment escrow $5.0m.
- 1. Funded debt160.0 + 15.0 + 1.2 + 0.8$177.0m
- 2. Debt like items, estimate3.0 + 4.5 + 2.5 + 1.0$11.0m
- 3. Working capital adjustment, estimate58.0 - 60.0-$2.0m
- 4. Estimated equity price paid at closing500.0 + 20.0 - 177.0 - 11.0 - 2.0$330.0m
- 5. Working capital adjustment, final56.6 - 60.0-$3.4m
- 6. Final equity price500.0 + 19.4 - 177.0 - 11.6 - 3.4$327.4m
- 7. Post closing adjustment327.4 - 330.0-$2.6mOwed by the seller, recovered from the $5.0m adjustment escrow; the remaining $2.4m is released to the seller.
A $500.0m headline became $330.0m of equity at closing and $327.4m after the true up. Of the $2.6m reduction, $1.4m came from working capital, $0.6m from cash and $0.6m from the newly found bonus accrual.
| Line | Estimate | Final | Change |
|---|---|---|---|
| Enterprise value | 500.0 | 500.0 | 0.0 |
| Plus cash | 20.0 | 19.4 | -0.6 |
| Less funded debt | (177.0) | (177.0) | 0.0 |
| Less debt like items | (11.0) | (11.6) | -0.6 |
| Working capital adjustment | (2.0) | (3.4) | -1.4 |
| Equity purchase price | 330.0 | 327.4 | -2.6 |
The locked box
A locked box fixes the equity price before signing, from a balance sheet at an agreed historical date, the locked box date, which has usually been audited or reviewed. Cash, debt, debt like items and working capital are all read off that balance sheet once, and there is no closing statement and no true up. Economic ownership passes to the buyer at the locked box date: profits earned after it belong to the buyer, and so do losses.
Because the seller still controls the business between the locked box date and closing, the buyer's protection is a covenant against leakage. Leakage means value passing from the company to the seller or its affiliates: dividends, management or monitoring fees, bonuses tied to the sale, payments to related parties, waived debts owed by the seller, and the company paying the seller's deal costs. Any leakage is repaid by the seller dollar for dollar, usually for a fixed period after closing, without the thresholds and caps that apply to warranty claims. Permitted leakage, such as ordinary salaries or an agreed fee, is listed and priced in.
Since the buyer gets the profits from the locked box date, sellers ask to be compensated for the time their price is outstanding. The ticker is that compensation: a daily amount added to the price from the locked box date to closing, set either as an interest rate on the equity price or as an estimate of the cash the business generates each day. Locked boxes favour sellers in competitive processes, because the price is certain and bids are easy to compare, and favour buyers who have done thorough diligence on the locked box balance sheet.
- Locked box date
- The balance sheet date the price is struck on, typically the latest audited or reviewed month end.
- Annual ticker rate
- The agreed rate of compensation to the seller, often reflecting the cash yield of the business or a cost of funds.
Halden Packaging sold on a locked box instead
- Same business, EV $500.0m. Locked box balance sheet: cash $20.0m, funded debt $177.0m, debt like items $11.0m, NWC equal to the $60.0m peg.
- Ticker 6.0 percent a year on the equity price. Closing is 92 days after the locked box date.
- After closing the buyer finds a $2.0m dividend, a $0.8m management fee paid to the seller and a $1.2m sale bonus paid in the box period, none of them permitted.
- 1. Locked box equity price500.0 + 20.0 - 177.0 - 11.0 + 0.0$332.0m
- 2. Ticker per day332.0 x 6.0% / 365$0.0546m (about $54,600)
- 3. Total ticker0.054575 x 92$5.02m
- 4. Price paid at closing332.0 + 5.02$337.02m
- 5. Leakage repaid by the seller2.0 + 0.8 + 1.2$4.0m
- 6. Net price to the seller337.02 - 4.0$333.02m
The locked box gave the seller certainty of $332.0m plus a $5.02m ticker for the 92 days the buyer owned the economics without paying for them. The $4.0m of leakage came back to the buyer dollar for dollar, leaving the seller $333.02m.
Choosing a mechanism, and what goes wrong
Completion accounts suit buyers when the target's balance sheet moves a lot, when there is no reliable recent balance sheet to lock, or when the business is being carved out of a larger group and its standalone accounts do not yet exist. Locked boxes suit sellers in auctions and stable businesses with good monthly reporting. Each side can try the other: a buyer facing a locked box insists on thorough diligence of the box balance sheet and a broad leakage definition; a seller facing completion accounts pushes for a collar and a small escrow.
The mechanics interact with the rest of the deal. Representation and warranty insurance, now common in US sponsor deals, generally does not cover purchase price adjustments, so the adjustment escrow remains. And the closing mechanics feed straight into returns: the sponsor's equity check is the equity price, so a missed debt like item costs the fund a dollar of equity for every dollar missed.
| Feature | Completion accounts | Locked box |
|---|---|---|
| Balance sheet used | Actual, at closing | Historical, at the locked box date |
| When economic risk passes | At closing | At the locked box date |
| Price certainty at signing | Low until the true up | High |
| Main buyer protection | True up and adjustment escrow | Leakage covenant, dollar for dollar |
| Seller compensation for the gap | Not needed | Ticker |
| Post closing disputes | Common, on definitions and estimates | Limited to leakage |
| Typical setting | US deals, carve outs, volatile working capital | European sponsor deals, competitive auctions |
Templates for this lesson
Included with a Premieur membership.
- WordLetter of intentAn illustrative non binding LOI for a control acquisition, cash free and debt free with a working capital peg, plus a term summary. Not legal advice.Download
- ExcelClosing statement and working capital pegThe peg from a trailing average, enterprise to equity price on estimate and final statements with the escrow true up, the same deal on a locked box, and grids on ticker, timing and collar.Download