Classify, gross up, measure related-party payments at arm's length, deduct: and why the definition decides more than the arithmetic.
Leakage is every payment of value from the target to the seller or its affiliates between the locked box date and completion that the agreement does not list as permitted, measured with the costs and taxes it triggers, and recovered euro for euro. On an illustrative €64.0 million equity value, a dividend, a sale bonus with its social charges, seller fees with irrecoverable VAT and an off-market related-party charge add up to €3.99 million of leakage, 6.23 per cent of the price. Read the definition narrowly and €0.44 million of it disappears.
Worked in full in Closing the Deal by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
In a locked box deal the price is fixed on a balance sheet at a past date and the buyer owns the economics from that date. Nothing stops the seller, who still controls the company until completion, from taking value out in the meantime. The leakage covenant is what stops it: the seller promises that no value has left since the box date except items listed as permitted leakage, and indemnifies the buyer for anything else. Permitted leakage is already in the price, because the buyer agreed to it when it priced the box. Everything else is a deduction.
| Item | Amount | Treatment |
|---|---|---|
| Dividend to the seller, paid on day 15 | 2.00 | Leakage |
| Sale bonus to managers, triggered by the deal | 0.80 | Leakage, plus employer social charges at 40% |
| Seller's adviser fees invoiced to the target | 0.60 | Leakage, plus irrecoverable VAT at 20% |
| Services from a seller affiliate: paid | 0.40 | Leakage to the extent above arm's length |
| Same services at arm's length | 0.25 | |
| Quarterly monitoring fee to the sponsor, listed | 0.15 | Permitted |
| Fees of a seller-appointed director, ordinary course, listed | 0.05 | Permitted |
| Equity value at the box date | 64.00 | Ticker 4.0% a year |
1. Classify. Take every payment to the seller, its affiliates and its advisers since the box date. Strike out the items on the permitted leakage schedule: 0.15 + 0.05 = 0.20 stays in the price.
2. Gross up for what the payment triggered. Sale bonus: 0.80 + 0.80 × 40% = 1.12. Adviser fees: 0.60 + 0.60 × 20% = 0.72.
3. Measure related-party payments against arm's length. 0.40 − 0.25 = 0.15.
4. Add up. 2.00 + 1.12 + 0.72 + 0.15 = 3.99.
5. Deduct. Items notified before completion come off the price on the day; items found later are claimed under the indemnity.
In Excel, one row per payment with an in-or-out switch: =SUMPRODUCT(Amount*(1+AssocCostRate)*IsLeakage), with the arm's length price already netted in the amount column.
| Line | Amount |
|---|---|
| Equity value at the box date | 64.00 |
| Ticker: 64.0 × 4.0% × 90 ÷ 365 | 0.63 |
| Less leakage notified before completion: 2.00 + 1.12 + 0.72 | -3.84 |
| Price paid at completion | 60.79 |
| Less indemnity claim for the related-party excess, found later | -0.15 |
| Net price for the shares | 60.64 |
The seller receives €3.99 million less than the headline plus ticker, and loses nothing it should have kept: it already took the €2.00 million dividend out of the company, and the other €1.99 million is value that left the company for the seller's benefit. The buyer, for its part, ends up where it priced the deal.
One smaller point is worth checking in the drafting. The ticker runs on the full €64.0 million for all 90 days, yet €2.00 million left on day 15. Strictly, the buyer pays a ticker on cash it never received: 2.00 × 4.0% × 75 ÷ 365 = €16,438. Small here, larger on a big early dividend, and simple to fix by deducting interest on leakage from the date it was paid.
| Definition | Leakage | Lost to the buyer |
|---|---|---|
| Full: payments plus associated costs and taxes | 3.99 | 0.00 |
| Net of the tax relief on the bonus, at 25% | 3.71 | 0.28 |
| Narrow: payments only, no associated costs | 3.55 | 0.44 |
| Sale bonus listed as permitted leakage | 2.87 | 1.12 |
| Both: bonus permitted and no associated costs | 2.75 | 1.24 |
The biggest line is not a calculation at all: whether the sale bonus is on the permitted schedule. A seller who gets it listed shifts €1.12 million of its own deal cost to the buyer, and a buyer who accepts it should take it off the equity value before signing, because once it is permitted it is in the price. The "net of tax relief" wording is a fair compromise when the relief is real and usable in the target; it is not when the target has losses to absorb it first.
Two, in opposite directions. Buyers forget the associated costs: the employer social charges on a bonus and the VAT the target cannot recover on fees it should never have paid, here €0.44 million, are part of the value that left. In the other direction, a buyer’s completion statement sometimes double counts permitted leakage: deducting the €0.20 million of listed items from the price again, as if they were leakage, would take the deduction to €4.19 million. Permitted leakage is priced once, in the equity value, and never again. The box earns cash for the buyer as well, which is what the ticker is meant to pay for; the arithmetic of that side is in how to calculate a locked box ticker.
Leakage = every non-permitted payment to the seller side since the box date, grossed up for the costs and taxes it triggered, related-party payments measured above arm's length, deducted euro for euro: €3.99 million here, 6.23 per cent of the equity value. The definition decides €1.24 million of it. The locked box file with the ticker, the longstop and the leakage schedule is in the free workbook for this case, and the comparison with the other mechanism is in locked box vs completion accounts.
Payments from the target to the seller side that the buyer agrees in advance and lists in the agreement, such as a monitoring fee or ordinary-course director fees. They are not deducted from the price because the buyer priced them in. Here 0.20 million of listed items stays in the price, while 3.99 million of other payments is deducted.
Usually yes, unless it is listed as permitted. A bonus triggered by the sale benefits the seller and costs the target the bonus plus employer social charges: 0.80 million plus 40 per cent is 1.12 million. If the seller gets it on the permitted schedule, the buyer bears that cost and should reduce the equity value before signing.
It should, and the drafting must say so. Leakage is the value that left the company, which includes the costs a payment triggered. On 0.60 million of seller adviser fees with 20 per cent irrecoverable VAT and a 0.80 million bonus with 40 per cent social charges, the associated costs are 0.44 million that a narrow definition leaves with the buyer.
This article is one calculation from Closing the Deal. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: corporate finance, valuation and markets → · All 681 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.