Introduction

One of the key matters on which the parties must reach agreement in mergers and acquisitions (“M&A”) transactions is the purchase price. However, particularly in complex corporate acquisitions, determining the purchase price involves more than merely agreeing on a specific figure. The financial position, indebtedness, working capital requirements and cash position of the target company, as well as any changes that may occur during the period leading up to closing, may directly affect the amount ultimately payable by the purchaser for the target company.

Accordingly, M&A transactions also require the parties to determine how the value reached as a result of the valuation of the target company will be reflected in the share purchase agreement (“SPA”) and how the economic risk between signing and closing will be allocated between the parties. The principal mechanisms used for this purpose in practice are the locked box and completion accounts mechanisms. In addition, particularly where the purchaser and the seller have differing expectations regarding the future performance of the target company, earn-out arrangements, under which a portion of the purchase price is linked to the achievement of certain financial or operational targets in the future, are also frequently used.

Although all three mechanisms aim to ensure that the ultimate purchase price appropriately reflects the economic value of the target company, they differ significantly in terms of which party bears the pricing risk, whether a post-closing price adjustment is made and the nature of the potential disputes that may arise between the parties.

A. PURCHASE PRICE IN M&A TRANSACTIONS AND THE FUNCTION OF PRICE ADJUSTMENT MECHANISMS

The enterprise value determined as a result of a company\'s valuation and the equity value payable to its shareholders are not necessarily the same. Factors such as the target company\'s cash and debt position and its level of working capital are taken into account when determining the ultimate amount payable by the purchaser for the shares based on the enterprise value.

For example, the fact that the parties have agreed on a certain enterprise value for the target company does not necessarily mean that this amount will be paid directly to the seller at closing. While financial indebtedness exceeding the level agreed by the parties may, as a general rule, reduce the amount payable for the shares, the cash held by the target company or a positive difference above the agreed level of working capital may, depending on the agreed formula, increase the purchase price.

The key question at this point is the date as of which these financial metrics are to be measured.

In M&A transactions, several weeks may pass between the signing of the SPA and the closing date on which the shares are transferred, and where regulatory approvals are required, this period may even extend to several months. During this period, the target company continues its business operations, incurs indebtedness, collects receivables, makes payments and, consequently, its financial position continues to change.

The locked box and completion accounts mechanisms essentially determine how the changes in value and economic risk arising from this timing difference are allocated between the purchaser and the seller.

B. LOCKED BOX MECHANISM

1. General Overview

Under a locked box mechanism, the purchase price is determined on the basis of financial statements prepared as of a specific date prior to closing and accepted by the parties. This date is commonly referred to as the locked box date.

The parties assess the target company\'s debt, cash and working capital position by reference to these financial statements and determine the amount payable for the shares at the signing stage of the SPA. Accordingly, as a general rule, no separate purchase price adjustment is made following closing.

This is also the rationale behind the term “locked box”: the value of the company is effectively locked in as of a particular date, and any reduction in that value for the benefit of the seller or persons affiliated with the seller after such date is restricted.

2. Leakage

One of the most important elements of a locked box mechanism is the regulation of leakage.

Since the purchase price is determined as of the locked box date, any transfer of value from the target company to the seller or persons affiliated with the seller between the locked box date and closing may reduce the economic value acquired by the purchaser.

For this reason, SPAs generally include a no-leakage undertaking given by the seller.

Depending on the nature of the transaction, leakage may include:

• dividends or other distributions made to the seller or its related parties;
• returns of capital;
• loans granted or payments made to shareholders;
• transaction fees paid to the seller or its related parties; and
• certain transfers of value to related parties on terms other than arm\'s-length terms.

However, certain payments required in the ordinary course of the target company\'s business and agreed in advance by the parties may be designated as permitted leakage. Payments expressly defined as permitted leakage are not treated as a breach of the purchase price arrangements.

For the locked box structure to operate effectively, the concepts of leakage and permitted leakage should therefore be defined as clearly as possible in the SPA. Otherwise, disputes may arise following closing as to whether a particular payment constitutes a prohibited transfer of value or forms part of the target company\'s ordinary course of business.

3. Impact of the Locked Box Mechanism on the Parties

The locked box structure provides a significant degree of price certainty, particularly for the seller. At signing, the seller knows the amount it will receive in consideration for its shares and is not subsequently exposed to an extensive post-closing purchase price adjustment process.

From the purchaser\'s perspective, however, the reliability of the mechanism largely depends on the accuracy of the locked box financial statements and the financial and legal review conducted in respect of such financial statements. Accordingly, the locked box method is generally more suitable for transactions in which comprehensive due diligence can be performed and reliable historical financial statements are available.

The parties may also agree to increase the purchase price by a specified amount or rate to reflect the assumption that the economic value of the target company accrues for the benefit of the purchaser between the locked box date and closing. In practice, such arrangements may be referred to as value accrual, a ticking fee or similar concepts.

C. COMPLETION ACCOUNTS MECHANISM

1. Finalisation of the Purchase Price Following Closing

Unlike the locked box method, under the completion accounts mechanism the purchase price is not fully fixed at the signing date.

The parties generally determine an initial or estimated purchase price in the SPA. The actual financial position of the target company as of the closing date is subsequently determined on the basis of completion accounts, and the purchase price is adjusted upwards or downwards in accordance with the formula agreed between the parties.

A typical purchase price calculation may, for example, take the following form:

Enterprise Value
(-) Net Debt
(+/-) Working Capital Adjustment
= Equity Value

However, since the items to be classified as “debt”, “cash” or “working capital” may differ depending on the target company and the particular transaction, merely including the formula in the SPA will not generally be sufficient.

2. Net Debt and Working Capital Adjustments

One of the most critical elements of a completion accounts mechanism is the definition of net debt.

While conventional financial indebtedness, such as bank loans, will generally clearly fall within the scope of net debt, whether items such as shareholder loans, accrued but unpaid interest, finance lease liabilities, transaction expenses, certain tax liabilities or similar items are to be included in net debt should be specifically addressed on a transaction-by-transaction basis.

Similarly, the calculation of net working capital constitutes an important element of the purchase price adjustment.

It is generally assumed that the target company requires a certain level of working capital in order to continue operating in the ordinary course. The parties may therefore determine a target working capital level by reference to the company\'s historical financial data and business model.

If the actual working capital at closing is below the target level, the purchase price may be adjusted downwards; if it exceeds the target level, the purchase price may be adjusted upwards in accordance with the formula agreed between the parties.

3. Determination of Accounting Principles

A significant portion of disputes arising in connection with completion accounts mechanisms does not result from the calculation formula itself, but rather from the manner in which the underlying accounting figures are prepared.

It is therefore important for the SPA to specify the accounting principles to be applied in preparing the completion accounts and the order of priority between such principles.

For example, the parties may agree that the completion accounts will be prepared by applying, in the following order:

1. the specific accounting principles expressly set out in the SPA;
2. the accounting policies consistently applied by the target company in prior periods; and
3. the applicable accounting standards.

An accounting hierarchy structured in this manner may help prevent the parties from subsequently adopting different methodologies in relation to whether a particular item should be included in the calculation.

4. Post-Closing Objection and Expert Determination Mechanism

Under a completion accounts structure, the SPA generally provides specific time periods for preparing the accounts, submitting them to the other party and raising objections.

If the parties are unable to agree on a calculation, they may provide for the relevant financial or accounting matters to be determined by an independent financial expert or auditor.

The key consideration in this context is to distinguish between calculation disputes and disputes concerning legal interpretation. For example, while the mathematical amount of a particular balance sheet item may be determined by an expert, whether a particular liability falls within the definition of “Net Debt” under the SPA may require legal interpretation.

If this distinction is not clearly reflected in the SPA, the jurisdiction of the independent expert may overlap with that of the competent court or arbitral tribunal in respect of the same dispute.

D. EARN-OUT MECHANISM

1. Reflecting Future Performance in the Purchase Price

The earn-out mechanism serves a different purpose from the locked box and completion accounts mechanisms.

While locked box and completion accounts mechanisms primarily seek to ensure that the value of the target company as of closing is appropriately reflected in the purchase price, an earn-out mechanism links a portion of the purchase price to the target company\'s post-closing performance.

This method becomes particularly relevant where the purchaser and the seller have differing expectations regarding the target company\'s future performance.

For example, the seller may argue that the target company is expected to grow significantly over the next two years and that its valuation should reflect this expected growth, while the purchaser may be unwilling to pay for such value at closing on the basis that the anticipated growth has not yet materialised.

The parties may bridge this valuation gap through an earn-out mechanism. The purchaser pays a specified amount at closing, while an additional portion of the purchase price becomes payable if the target company achieves the agreed performance targets.

2. Determination of Earn-Out Parameters

Earn-out payments may be linked to various financial or operational criteria.

In practice, such criteria may include:

• revenue;
• EBITDA;
• net profit;
• retention of certain customers or contracts;
• achievement of a specified sales volume;
• launch of a new product; or
• obtaining a particular licence or regulatory approval.

Although EBITDA is frequently used among financial performance metrics, significant disputes may arise if the manner in which EBITDA is to be calculated is not sufficiently clearly defined.

Whether one-off expenses are included, transactions with group companies, management charges, new investments, depreciation policies or changes made to the corporate structure following closing may all directly affect the outcome of an earn-out calculation.

Accordingly, a provision merely stating that “an additional payment will be made if EBITDA exceeds a certain level” will generally not be sufficient. The methodology for calculating the relevant metric should also form an integral part of the SPA.

3. Post-Closing Management and Protection of the Seller

One of the most sensitive aspects of an earn-out mechanism is that control over the target company generally passes to the purchaser following the transfer of the shares.

In such circumstances, business decisions taken by the purchaser may directly affect whether the seller becomes entitled to receive the earn-out payment.

For example, the purchaser may defer growth investments, redirect relationships with certain customers to another group company, charge significant intra-group service fees to the target company or materially alter the target company\'s commercial strategy, thereby making it more difficult for the earn-out criteria to be achieved.

For this reason, from the seller\'s perspective, it is important for the SPA to include protective provisions regarding matters such as:

• continuation of the business in the ordinary course;
• restrictions on transferring certain activities to other group companies;
• restrictions on changing accounting policies during the earn-out period;
• requirements for related-party transactions to be conducted on arm\'s-length terms; and
• the seller\'s right to access and review certain financial information.

Earn-out arrangements are not specifically regulated as a standalone legal concept under Turkish law. Nevertheless, within the framework of freedom of contract, the parties may agree that a certain portion of the purchase price will become payable upon the occurrence of specified future events. Depending on the structure of the relevant arrangement, an earn-out payment linked to the occurrence of a particular condition may also be assessed within the framework of the provisions of the Turkish Code of Obligations governing conditional obligations.

In this respect, where the occurrence of the condition underlying the earn-out payment is within the purchaser\'s control following the acquisition, the parties\' obligations arising from the principle of good faith become particularly relevant. If the purchaser prevents the agreed condition from being satisfied in a manner contrary to the principle of good faith solely for the purpose of avoiding the additional payment, this may, depending on the circumstances of the particular case, have consequences under the provisions of the Turkish Code of Obligations governing conditional obligations.

CHOOSING BETWEEN LOCKED BOX, COMPLETION ACCOUNTS AND EARN-OUT

There is no single purchase price mechanism that can be regarded as superior for every M&A transaction.

A locked box mechanism may offer advantages where reliable historical financial information is available, comprehensive due diligence can be conducted and, in particular, the seller seeks to eliminate post-closing price uncertainty.

By contrast, completion accounts may be preferable where material changes in the target company\'s financial position may occur between signing and closing or where the purchaser wishes to determine the purchase price by reference, as closely as possible, to the target company\'s actual financial position as of the closing date.

An earn-out, on the other hand, addresses a different need. Where there is significant uncertainty regarding the target company\'s future performance or a valuation gap between the purchaser and the seller, an earn-out may facilitate completion of the transaction by linking a portion of such valuation gap to future performance.

These mechanisms are not necessarily mutually exclusive.

An SPA may determine the purchase price using a locked box mechanism while also providing for an additional amount to be paid by way of an earn-out. Similarly, following an adjustment of the target company\'s financial position as of closing through a completion accounts mechanism, the SPA may provide for a separate earn-out payment linked to the company\'s performance in subsequent years.

Accordingly, the design of the purchase price mechanism involves not only determining which individual mechanism should be selected, but also assessing how different mechanisms may operate together in a manner consistent with the economics of the transaction.

CONCLUSION

In M&A transactions, the purchase price is often not merely a single figure, but rather the outcome of the parties\' allocation of risk in relation to the target company\'s historical performance, its financial position as of closing and its future performance.

While the locked box mechanism prioritises price certainty and post-closing simplicity, the completion accounts method enables the purchase price to be determined by reference to the target company\'s actual financial position as of the closing date. An earn-out, meanwhile, may bridge differing valuation expectations between the purchaser and the seller, particularly where there is uncertainty regarding the target company\'s future performance.

Regardless of the mechanism selected, however, its effectiveness depends not only on the underlying economic formula but also on the extent to which that formula is reflected in the SPA in a clear and predictable manner. An SPA that does not adequately define transaction-specific concepts such as net debt, working capital, leakage or EBITDA, or that fails to sufficiently regulate the applicable accounting policies, calculation procedures and dispute resolution mechanisms, may cause a purchase price that the parties believed to have agreed upon to become the subject of renewed negotiations or disputes following closing.

Accordingly, selecting the appropriate purchase price mechanism in an M&A transaction is far more than a technical extension of the valuation exercise. The purchase price mechanism constitutes one of the fundamental contractual elements of the transaction, determining how economic risk between signing and closing—and, in certain cases, following closing—is allocated between the purchaser and the seller.