The document discusses: 1) Valuing options that are part of executive compensation packages can be complex due to different valuation models. Options help ensure executives' interests are aligned with company performance but discounts may need to be applied for non-transferable options. 2) Selling non-core business lines can be challenging and require preparation. It discusses the importance of preparing financials, identifying key risks, resolving any legal or tax issues, and engaging advisors to help maximize sale value. 3) Settling on a sale price for a business involves comparing the locked box and completion accounts approaches. Locked box fixes the sale price at a historic date while completion accounts adjusts for events until closing.

1. ®
The Global
October 2012
Corporate Advisor
The Corporate Finance newsletter of Crowe Horwath International
Welcome to the October edition of the Global Corporate Advisor
(GCA) newsletter
This month, Olivier Grivillers from the The GCA team is here to respond to
Crowe Horwath Paris office explores your needs relating to M&A transaction
the issues around valuing options used support, valuations, M&A advisory
as part of executive compensation services and related services. If there
packages. Options help ensure that is something you’d like to see in future
executives have a clear financial issues of the GCA newsletter, don’t
interest in company performance. hesitate to contact me or a member of
However, they can be complex, and the team to discuss your ideas.
executives, remuneration specialists
Here’s hoping the year closes out
and valuation experts need to
strong for all of us!
understand the different ways of
valuing options.
We also examine the challenges
presented by non-core businesses. Marc Shaffer
Some company managers are keen Chairman, Global Corporate Advisors
to divest these business lines – marc.shaffer@crowehorwath.com
particularly if they act as a drag on the
overall operations. But the process can
take significant effort and planning to
prepare a non-core business line for Inside This Issue:
sale. Fintan Connolly, Liam Hawkswell
and the Crowe Horwath team in Welcome 1
Brisbane provide their insights into this
complicated subject. Valuing Options in Executive
Contact Us One challenging part of any business
Salary Packages 2
For further information, contact: sale is settling on a sale price. In this Getting Your Ducks in a Row:
edition, Stefan Jansen from Crowe
the Virtues of Preparing a Non-
Marc Shaffer Horwath’s Netherlands office takes us
Chairman, core Business Line for Sale 6
through two methods of calculating the
Global Corporate Advisors price of target business: locked box and
Getting the Price Right:
marc.shaffer@crowehorwath.com completion accounts.
Comparing the Locked Box
For your local contact, visit our and the Completion Accounts
website at www.crowehorwath.net Approaches 9
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©2012 Crowe Horwath International 1

2. ® October 2012
Valuing Options in Executive Salary Packages
By Oliver Grivillers, Paris
Introduction Figure 1: How executives are compensated
Company managers are Other miscellaneous
compensated in a variety of ways. Social advantages
According to a 2009 study of
Fortune 100 companies, salary and 5%
bonuses account for less than 50% Stock options
of an executive’s total compensation 10%
(Figure 1).
Top-tier executive pay also consists 22%
of significant financial instruments Bonus 24%
such stock options and warrants. This
makes it important for executives,
remuneration specialists and
valuation experts to understand 23%
option valuation methods. 16%
In developing remuneration
Other deferred
strategies, companies need to view
compensation
executives as ‘investors’. Options Basic salary
ensure that executives have a clear
financial interest in how a company
Source: Financial incentives for executives, Economica (2010)
performs. However, the issues
surrounding options can be quite
complex. Figure 2: Option gain profile
To accurately value the deferred
compensation of executives,
companies may need to modify their Gain Buyer
current option valuation models
– including the widely used Black-
Scholes model. Options that are
issued on a non-transferable basis
should have a discount applied
to their value. Based on research Premium
undertaken to date, this discount
should be in the order of 20% to 40%. Strike price Price of the
This article will cover three issues: underlying asset
at maturity
n valuing options
n the Black-Scholes model
n non-transferable options
valuation.
Seller
Valuing options Loss
An option is a contract between two
parties, where one party gives the This asset will be bought or sold at a Under a call option, the buyer will
other the right (but not the obligation) predetermined price, called the strike experience a loss limited to the amount
to buy (known as a call option) or sell price. The option can be executed of the premium if they forgo the option.
(a put option) an asset in exchange during a period of time (in the case of Or they may stand to gain a potentially
for the payment of a premium. US-style options), or on a precise date unlimited profit (see Figure 2).
(European-style options).
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©2012 Crowe Horwath International 2

3. ® October 2012
Calculating the option’s value Figure 3: The value of a call option
An option’s value comprises two
components (figure 3):
Strike price
n Intrinsic value: this represents the
Value of the option
value of exercising an option now.
If the price of the underlying asset
is greater than the strike price, an
executive can make a profit. If the
Time value
price of the underlying asset is
below the strike price, an executive
will make a loss amounting to the Intrinsic value
premium price.
n Time value: the current price of the Value of the underlying asset
option minus its intrinsic value. Time
value will vary based on movements
in the price/value of the underlying n the instantaneous standard n The underlying security price:
asset, and the amount of time deviation of the return on the as this price changes, so does the
remaining before the option expires. underlying asset (volatility); and value of an option. For instance, as
the value of the underlying asset
The Black-Scholes n cumulative standard normal
distribution.
rises, the value of a call option will
typically increase and the value of a
model Using Black-Scholes to put option will fall.
There are a number of different models determine option values n The strike price: the higher the
for option valuation, including the Cox- Under this model, there are six factors strike price, the lower the value of
Ross-Rubinstein model, the Monte that affect the price of an option. Table a call option (assuming a constant
Carlo, and the most famous model, the 1 shows how call and put option prices value of the underlying asset). The
Black-Scholes model. are affected by movements in the listed higher a call option’s strike price,
The Black-Scholes model can be factors (shown by the green and red the less chance the price of the
used to value simple options, such as arrows). underlying asset will exceed it.
stock options and warrants. The model These factors are explained in more
calculates the possible prices of the detail below.
underlying asset at maturity, and the
probabilities of these prices occurring.
This is based on the fundamental Table 1: Determining movements in option prices
assumption that prices are a random
variable with a standard normal Evolution of the factors Call option price Put option price
cumulative distribution.
  
The Black-Scholes formula is Underlying security price
  
complicated sets of formulas that
  
considers: Strike price
  
n the current price of the underlying   
asset; Volatility of the underlying asset
  
n the option’s strike price;   
Time to maturity
n the time remaining until maturity (in   
years);   
Risk-free rate
  
n the continual annual risk-free rate
(a theoretical rate of return with no Dividends or coupons
  
risk);   
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©2012 Crowe Horwath International 3

4. ® October 2012
n Volatility of the underlying asset: is higher than €4.39, the gain for the Academic studies
the value of both a call and a put holder will be the difference between Restricted stocks have many of the
option rises with the volatility in the the underlying asset price and the characteristics of non-transferable
value of the underlying asset. The exercise price (€4.39), less the option options, and many studies on these
more volatile the underlying asset, price (€1.11). If the underlying stock stocks have been conducted in the US.
the more likely its value will rise or price is below €4.39, the holder will lose The studies listed in Table 3 can help
fall sharply. As options reward risk, the option price (€1.11) measure the extent to which stocks
the greater that risk is, the greater have been discounted due to the
the potential financial upside –
equating to a higher option value.
Non-transferable restrictions imposed.
n Time to maturity: the longer the
options valuation Table 3: Academic studies and stock
time until an option matures, the A number of recent studies show that discounts
greater the likelihood of fluctuations many stock option–based executive
in the price of the underlying asset. management remuneration packages Average
mainly include non-transferable stock Author Year
This increased risk raises the discount*
option’s value. options. The term ‘non-transferable’
US Securities
means that the option is neither
n The risk-free rate: is a theoretical and Exchange 1971 23%
tradable nor exercisable during a
rate of return on an investment with Commission
certain period.
no risk – generally taken to be the M Gelman 1972 33%
yield on AAA-rated government As this option cannot be transferred
to another party, it is worth less than a J M Maher 1976 35%
bonds. If the risk-free rate rises,
the value of the call option will too. classic option. R R Trout 1977 34%
The further away the maturity date To value these options, the valuation W L Silver 1991 34%
on a option is, the further away model must take into consideration an B A Johnson 1999 20%
the payment date of that cost. The option’s non-transferability (that is, the
holder of a call option will thus have option holder has to deal with a liquidity *The price gap between a non-restricted stock and a
restricted stock.
a cash advantage that depends on constraint on the financial instrument)
the level of the risk-free rate. and the option’s non-exercisability
n Dividends or coupons: the (the option holder suffers from an A 2001 study by Brenner examined the
payment of a dividend or coupon opportunity cost during the period the impact of non-transferable exchange
lowers the value of the underlying option cannot be exercised). options on the Israeli money market.
asset. This lowers the value of a call The options were issued by the Israeli
The studies below show how the non- central bank, the Bank of Israel, and
option and raises the value of a put transferable nature of some options
option. were not transferable before maturity.
affects their value.
In this example (Table 2), an investor These options were compared to
Accounting approach similar options issued by commercial
pays €1.11 today for the right to buy
a share at €4.39 in seven years time. International Financial Reporting banks and negotiated on the financial
This share is currently worth €3.92. In Standards 2 (IFRS 2) does not always market. The non-transferable options
seven years, the underlying stock price consider the non-transferability of the traded at a discount of around 20%
will be worth between zero and infinity option valuation from an accounting over the options issued by commercial
Euros. If the underlying stock price point of view. However, it does take into banks with six months of maturity.
account the effect of the early exercise
Empirical studies
of options in accounting valuations. The
Table 2: Example of a call option impact of this is to decrease the time Another study was conducted on the
value of the option. The decrease in the French warrant market. In particular,
Underlying asset’s price it looked at the restricted capped
3.92 total value of the option depends on the
(in €) warrants issuances that took place
option’s maturity, and can vary between
Strike price 4.39 20% and 40%. between 2008 and 2010. The non-
transferability discounts observed are
Time to maturity (in days) 2,555.0
shown in Table 4.
Volatility as a % 25.0
Risk-free rate as a % 3.97
Dividend rate as a % 0.80
Value of the call 1.11
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©2012 Crowe Horwath International 4

5. ® October 2012
Olivier Grivillers is one of five authors of Financial Incentives for Executives, Economica (2010). This book
deals with option valuation issues for executive compensation packages.
Table 4: Non-transferability discounts in French warrants
Discount levels observed by operation
BSAAR (warrant) Non-transferability Non-transferability
Date Issuer
maturity (in years) period (in years) discount (in years)
December 2010 Aedian 7 2 30.5%
June 2010 Mersen 7 2 29.0%
May 2010 Eurofins 7 2 32.5%
October 2009 Monsieur Bricolage 5 2 29.5%
September 2009 Ausy 7 2 32.3%
July 2009 Orpéa 6 2 28.8%
April 2009 Bonduelle 7 1.5 25.0%
December 2008 Overlap Group 7 2 34.0%
October 2008 Nextradio TV 5 2 30.0%
August 2008 STEF-TFE 7 2 34.0%
July 2008 Keyrus 6 2 20.0%
June 2008 Assystem 7 2 24.6%
May 2008 LVL medical 7 2 20.9%
January 2008 Akka Technologies 5 2 32.0%
January 2008 Proméo 7 2 19.3%
January 2008 Espace production 7 2 25.3%
Median discount 30.0%
Source: Transaction note available on the Autorité des Marchés Financiers (French financial markets authority) website
For more information:
Olivier Grivillers is a Partner at Horwath Audit in France. He can be reached at +33 1 4105 9848 or ogrivillers@horwath.fr.
Audit | Tax | Advisory www.crowehorwath.net
©2012 Crowe Horwath International 5

6. ® October 2012
Getting Your Ducks in a Row: the Virtues of Preparing a
Non-core Business Line for Sale
By Fintan Connolly and Liam Hawkswell, Brisbane
Companies face many choices around n What return to the buyer will the Divesting business lines that make a
what to do with non-core businesses. If business line provide, either as a significant contribution to company
these lines are underperforming, they stand-alone business or bolted on value and profits will invariably have a
may drag on the overall operation’s to a buyer’s operation? negative impact on valuations.
success by diverting limited resources
and distracting management attention.
In some cases, it may be time to sell
n Is the business more valuable
to a potential buyer than to the How can we
these divisions.
seller? Are there any likely target
buyers for the business line, and
maximize the sale
However, management should not rush what potential synergies could price of a business
to sell non-core businesses. It takes they derive from the acquisition/
careful effort and planning to get a non- purchase? line?
core division ready for sale. Vendors The key consideration in determining
n Does the business line have growth
need to be prepared for a potentially the sale price is often whether another
potential?
complex and involved sale process. As party can obtain greater value from
Chinese philosopher Sun Tzu said: “To n Are there any external factors your non-core business line than your
... not prepare is the greatest of crimes; that may adversely affect the sale company can. This is what makes a
to be prepared beforehand for any of the business line, including business line attractive to others.
contingency is the greatest of virtues”. negative perceptions of the
industry, regulation and the threat of Clearly explaining historical and
This article – targeted at private and
listed businesses – explores three
litigation? forecast financial performance
overarching questions the management Ensuring the non-core business Prospective buyers of your business
of corporations (‘sellers’) should line will typically consider its historical
line can stand alone
consider when deciding whether and forecast financials to determine
Potential sellers must make sure the its true value. As such, management
to divest a non-core business (the
business line can be successfully needs to make sure prospective
‘business line’):
carved out of their operations. In some buyers:
n Is the business line truly non-core? cases, a revised operating structure
or business model will be required if n understand the historical
n How can we maximize the sale performance of the business line
the business line is removed. Further,
price?
additional infrastructure may be n receive clear projections about
n How do we create an efficient sale required to effectively support and future financial performance
process? manage this business line once it is
separated (e.g. management and n are informed of any discrepancies in
Is the business line accounting systems). the historical financial performance
that are not reflected in forecasts.
truly non-core? Weighing up the potential This includes explaining how
proceeds of the sale adjusted profit is calculated
To answer this question, management
A seller needs to have an idea of how historically, and how this has been
needs to drill down and consider the
the sale of a business line will affect used as a basis for forecasts.
business line in the context of the
company’s overall operations. To its capital position. In the case of a Developing a clear financial
do this effectively, we recommend listed company, how could the sale
model
management uses the following of a business line and its capacity to
generate value and profits affect the Using financial models can help sellers
divestment checklist:
core business’s valuation? Further, and prospective buyers determine the
n What is our core business? does the business line generate value potential future growth and profitability
in its capacity to produce profits and of the business line. Detailed analysis
n Is the business line integral to the
assist the seller’s other business lines is required to ensure all underlying
core operations?
in creating shareholder value? drivers are identified and captured
n Do the costs associated with within models.
carving out these operations
outweigh the potential benefits?
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©2012 Crowe Horwath International 6

7. ® October 2012
To develop an effective financial
model, sellers also need to define the How do we create Understanding likely tax and
legal issues
assumptions that underpin the business
line’s financial projections across the
an efficient sale Sellers should also address any tax
areas of revenue, expenses, working process? and legal implications arising from
the sale of a business line, including
capital, financing, capital expenditure
To ensure the sale of a business line understanding:
and balance sheet.
proceeds as smoothly as possible,
n tax/deferred tax liabilities which may
When preparing a financial model that management needs to understand the
be trigged by the transaction
projects the performance of a business type of information potential buyers
line, a number of ‘normalizations’ require, and have this information n the terms of existing legal
will need to be made to the historic readily available. commitments, such as employee
financial performance of the business contracts and bank loan covenants
line. The process of normalizing
Complete a sell-side due
diligence report n likely contractual commitments
projected financials involves identifying
of the seller, that the buyer may
income and expenditure items that Commissioned by the seller, this report
require the seller to maintain
will be irrelevant to the business line, identifies issues potential purchasers
for a period after the sale (e.g.
and which are unlikely to re-occur or may have with a business line, allowing
warranties and undertakings, such
continue post-sale of the business line the seller to prepare for and mitigate
as a commitment by the seller that
(e.g. the writing off of a bad debt). It against such problems. In addition,
there are no undisclosed liabilities
is important to identify and properly the report may highlight the business’s
for which the buyer of the business
explain these normalizations when potential strengths and opportunities,
could become liable).
preparing the financial model. which can be used to the seller’s
advantage during the sale process. Prior to undertaking a sale process,
Dealing with financial and other sellers should also ensure that existing
risks Establish a data room legal documents are reviewed and
To perform well during the sale process, A data room is a physical or virtual up to date, such as shareholder
sellers need to identify and resolve any space where a potential purchaser agreements, company constitutions
issues before prospective buyers raise can access the key documents of and share registers. These documents
them. There are a number of ways a transaction target, including legal will typically be included in the data
sellers can do this, and build the value documents, accounting information, room.
of a business line, such as: and client or customer details. This
information can be provided in the Set up separate accounting
n hiring key management for the form of printed documents or through infrastructure
stand-alone business line an online facility. Generally, the lead Sellers may also need to separate the
n restructuring to eliminate overhead advisor to the sale process will help the accounting information of the business
costs seller set up a physical or electronic line from its main operations. This
data room. can make it easier for sellers to meet
n resolving outstanding disputes (if
Having a well-prepared data room is an the information requests of potential
any)
essential element of every competitive buyers, who will require separate
n ensuring the business line will have sale process. The data room allows accounting records for the non-core
its own legal agreements in place the seller to make sensitive information line – typically going back at least
(transferred/assigned or newly available to potential buyers in a three years. Further, the presence of
entered into/novated) to properly controlled environment. This is separate accounting records restricts
function after its sale (e.g. customer particularly important when multiple the ability of potential bidders and
and supplier agreements) buyers exist. competitors to access information
about the core business.
n identifying intellectual property that
is required by the business line and
ensuring it is properly licensed to/
owned by the business line.
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©2012 Crowe Horwath International 7

8. ® October 2012
Avoiding traps in Understand your potential
buyers
Your choice of broker, accountant,
lawyer and lead advisor will affect the
the sale process It is important to prequalify potential
efficiency and outcome of any intended
transaction. Meeting with your advisors
No two sale processes are the same. buyers before commencing the sale
as early as possible can help you plan
Negotiations over companies and process. The seller and its advisors
and identify issues, and leave enough
assets can vary greatly between single- should carefully select potential bidders
time to effectively resolve problems.
and multiple-party negotiations, and to avoid ‘tire kickers’ and fishing
auctions. expeditions by competitors. It’s always a good idea to ask
your advisors to explain how their
To avoid management becoming In some instances, the seller may want
experience and expertise is relevant to
distracted during the sale process, it to keep the sale process confidential.
your business line and its planned sale.
may be useful for sellers to identify a One way to do this is to use
separate management team for the confidentiality undertakings and non- Complete the sale process within
non-core business line, which can disclosure agreements. Because the a defined timeframe
operate independently of the core seller will be exchanging commercially
A structured sale process requires
business. This will help ensure that sensitive information with potential
careful planning. It should include
the core business does not lose key competitors, these measures can help
agreed timelines and the requirement
management in the process of sale, minimize the risks associated with a
for a non-binding offer (for the purchase
and that the business line being sold breach of confidentiality.
of the business line) to be lodged
will be adequately staffed to operate on Choose your advisors carefully before due diligence takes place.
a stand-alone basis in future.
Sellers should seek expert advice When entering any negotiation, you
This step also ensures that the before contemplating any corporate need options in case the sale process
operational performance of the non- transactions, whether they relate to does not unfold as planned. You also
core business line is closely monitored shares, assets, undertakings or capital need to be prepared to walk away from
so that the core business does not raisings. the deal if necessary.
suffer during the sale process. This
also ensures resources are efficiently
allocated.
For more information:
Fintan Connolly and Liam Hawkswell are part of Crowe Horwath’s Brisbane team.
Peter Bishop is Lead Principal in Crowe Horwath’s Corporate Finance team in Brisbane. He can be reached at +61 7 3233 3505
or peter.bishop@crowehorwath.com.au. Fintan is an Associate Principal with Crowe Horwath Brisbane’s Corporate Finance
team. He can be reached at +61 7 3233 3402 or fintan.connolly@crowehorwath.com.au.
Audit | Tax | Advisory www.crowehorwath.net
©2012 Crowe Horwath International 8

9. ® October 2012
Getting the Price Right: Comparing the Locked Box and the
Completion Accounts Approaches
By Stefan Jansen, Netherlands
When a business is sold, vendors and maximizes value. This makes it price, and no completion accounts
buyers must agree on a purchase important for buyers and sellers to be or completion audits have to be
price. This price is often based on aware of the issues surrounding each undertaken. This can prevent disputes
earnings multiples or cash flow– approach. over the purchase price and reduce
based valuations, and adjusted for transaction costs.
This article also discusses the
factors such as debt and working
relationship between an initial business Managing leakage in locked box
capital. However, the true picture of
valuation and the final sale price. transactions
a business’s financial position can
change between when a buyer agrees
on a price and signs the deal, and The locked box However, because there is no
adjustment process, the parties need
when it takes control of the company.
method to address the potential for value to
‘leak’ out of the business between
As a result, both buyers and sellers A locked box transaction calculates signing the deal and its completion.
should take steps to protect their the value of a business based on These leakages include management
position and maximize value. This its balance sheet at a certain point payments, dividends and bonuses.
article looks at two common methods in time. The price of the business is Buyers will likely request covenants,
for calculating the price of a target ‘locked’ from this date, and there are indemnities and warranties to guard
business: locked box and completion no adjustments after the deal has against this situation.
accounts. been completed. A buyer assumes all
economic ownership, risks and rewards Of course, some leakages, such as
In theory, these two methods should
from the locked box date. wages, are unavoidable in the normal
arrive at a similar value for the
operation of a business. So buyers
business. But in practice, the choice The advantage of this approach is and sellers should agree on a list of
of method can affect which party that it gives buyers and sellers a fixed permitted leakages. And a buyer must
receive assurances that the seller will
run the business properly between the
Figure 1: Completion accounts and locked box locked box date and deal close.
Completion accounts
Signing Determination of
Reference date Covenants of conduct purchase price
Agreed valuation/Working capital
Completion accounts
Anti-leakage covenants (locking the box)
Determination of purchase price Closing
Locked box
Economic ownership: Seller
Economic ownership: Buyer
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©2012 Crowe Horwath International 9

10. ® October 2012
A particular issue can arise when a As the global financial crisis began, worked example below (Figure 2). We
buyer intends to acquire a business use of the locked box method will discuss the factors of bridging value
that needs to be carved out from a declined sharply as buyers sought to price, and positive and negative
larger entity. In this case, it may be protection against exposure to risk. valuation adjustments.
hard for a buyer to identify the leakages (The locked box method traditionally
specific to the individual business line. favours sellers, as they can lock in Bridging value to price
a fixed purchase price and limit their In this example, a buyer has valued
In a locked box transaction, parties its target at US$27 million (the
downside risk.) However, during
usually agree on a fixed period where enterprise value). This value has
2009 locked box transactions rose
a buyer can raise leakage claims. This been reduced by US$3 million due to
in popularity, especially in France,
period can be as short as a couple of valuation adjustments, which include
Germany, Belgium, the Netherlands,
months, and is typically shorter than a unrecognized pension liabilities and
and Luxemburg due the rebound in
warranty period. adjustments to earnings.
confidence in these economies.
The completion Key considerations Further, after the accounts have
been closed off, differences may
accounts method in pricing arise between the pricing parameters
negotiated during the deal and the
An alternate approach is to allow the
parties to agree on a purchase price approaches actual amounts. These adjustments –
sometimes referred to as the ‘equity
that is subject to adjustments after the There are a number of important bridge’ – mostly relate to net debt,
deal has closed. This is known as the considerations for buyers and sellers working capital and capex adjustments.
completion accounts method. in determining a final purchase price They are grouped together as
The final purchase price will include an on a business sale. For instance, a ‘Adjustments finalized at completion
adjustment to take into account factors buyer wants to know that the target’s accounts’ in Figure 2.
such as cash, debt, working capital and financial statements are reliable and
assets. The precise factors will depend valid. Under either approach, a buyer is Positive valuation adjustments
on the sale and purchase agreement paying a price based on the business’s In this example, cash and current
negotiated between the two parties. value at a particular date. So it requires working capital balances add positively
access to management to identify any to the enterprise’s value. For cash,
One issue with this method is that pricing or resource issues. the assumption is that cash balances
it can involve protracted talks – and
In addition, a seller must ensure that, are not trapped. Cash can be trapped
disagreements – between buyers and
regardless of the pricing approach, the where restrictions exist on remittances
sellers over the final purchase price.
business’s financial position is accurate back to the parent company’s country.
This could mean the ultimate price is
and will not lead to a buyer resorting In this situation, a buyer would discount
not determined for months.
to litigation. The seller may also need the value of the cash on the balance
The differences between locked box to produce sound financial information sheet.
and completion accounts are shown in in short timeframes – including
Figure 1.
Negative valuation adjustments
in potentially complex carve-out
situations. A business’s valuation will be dragged
Continuing Further, as part of a transaction, a seller
down by debt, shortfalls in the required
level of working capital and unplanned
popularity of may request a buyer pays interest on
the equity value of a company, as it
spending.
the locked box only receives payment after closing In this example, working capital totals
US$2.8 million on closing, while
approach off the accounts. In a locked box deal,
a buyer is entitled to the benefits of normalized working capital is valued
owning the business after the locked at US$3 million. The buyer subtracts
Typically, completion accounts have
box date, and so it usually makes US$200,000 from the company’s value
been seen as a way for a buyer to
interest payments on the equity value as this amount must be invested by the
protect its financial position during a
of a company to the seller. purchaser to maintain required levels of
transaction. This is because the buyer
working capital.
has recourse to negotiate an adjusted
purchase price after the deal is closed. Deal example: The working capital mechanism is
Despite these advantages, industry
sources suggest around 50% of merger equity valuation based on a target working capital
amount that a buyer intends to acquire
and acquisition transactions use the To understand how the value of in a deal, assuming that this amount of
locked box method. a company relates to its eventual working capital is sufficient to operate
purchase price, we have provided a the business. Any deviations from the
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©2012 Crowe Horwath International 10

11. ® October 2012
Figure 2: Equity valuation
$40,000
$4,500
$30,000
$2,800
USD’000
$20,000 $3,000 $6,000 $3,000 $500
$27,000 Valuation adjustments $21,800
$10,000
Adjustments finalized at completion accounts
$-
Enterprise Valuation Cash and Debt Working Working Capital Purchase
value adjustments cash capital on capital spend vs. price
equivalents closing normalized budget
target amount of working capital will n capex mechanism: which is used increase in net working capital, but it
lead to adjustments in the purchase to control investment spending does not take into account the negative
price. between the signing and closing of impact on the debt position. In this
a deal. way, it allows a seller to manipulate the
The working capital mechanism should
purchase price.
be used in conjunction with a: By using these mechanisms, a seller
can protect its balance sheet position Further, in the example, the buyer
n net debt mechanism: which adjusts
right up to the close of a deal. For needs to include US$500,000 for
the purchase price for differences in
example, if a net working capital delayed expenditures. Together, all
actual net debt position compared
mechanism is applied without a net these adjustments mean the purchase
to the target net debt position
debt mechanism, a seller could pay price is calculated at US$21.8 million.
all its creditors. This would lead to an
For more information:
Stefan Jansen is a manager at Crowe Horwath Corporate Finance, the Netherlands. He can be reached at +31 24 372 5469 or
stefan.jansen@crowehorwath.nl.
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