Weil, Gotshal & Manges LLP A Comparison of Private Equity Acquisitions of Private Companies across the U.S., Europe and Asia By Doug Warner, Peter Feist, Simon Lyell and Dianna Lee Private equity sponsors who make private company acquisitions across the United States, Europe and Asia should be aware of key market and practice differences in how such deals are done in each region. An understanding of what approaches and terms are customary in each region, and which ones less so, is particularly useful for a sponsor participating in a competitive bid process in an unfamiliar market. Indeed, getting to terms with what is acceptable in each region can help manage a sponsor’s expectation of the type of transaction, and correspondingly the level of deal certainty and protection, it is likely going to end up with. Key Observations United States. Generally speaking, the deal terms for U.S. transactions tend to be more “buyer-friendly” (in the overall spectrum of deal terms globally). ■ Purchase Price: Purchase price on a U.S. deal is based on the buyer acquiring the target on an enterprise value “cash-free, debt-free” basis with a target working capital level. Pricing is determined based on a set of closing accounts dated as at closing, as opposed to the “locked box” approach based on historical accounts commonly seen in Europe. The use of closing accounts allows for a potential adjustment to the agreed-upon purchase price should the value of certain balance sheet items (e.g., debt, cash, working capital) as at closing differ to those which were estimated at the time of signing. Under this approach, the buyer assumes the risk and rewards of the business only as at closing, and the seller remains on the hook (by having to pay an amount, if any, due to the buyer based on the post-closing purchase price adjustment calculation) for any non-agreed changes to the relevant balance sheet items during the period between signing and closing. However, the European-style locked box mechanism is slowly becoming more common in the U.S. as parties seek to avoid post-closing purchase price disputes which can be a drain on time, effort and money for both buyer and seller. ■ Conditions: U.S. deals tend to have comparatively greater conditionality to closing and more termination rights for the buyer. A “no material adverse effect” clause is commonly included as a closing condition and representations and warranties are typically “brought-down” (i.e., repeated) at closing as another closing condition. This gives the buyer more conditions upon which it could terminate the deal if not met, and conversely gives the seller less certainty in closing the deal. Private Equity UPDATE Q 1 2016 GLOBAL Private Equity UPDATES 2016 Weil, Gotshal & Manges LLP 2 ■ Reverse Termination Fees: For U.S. deals with debt financing, it is common to include a reverse termination fee (typically 4% to 7% of enterprise value depending on deal size) which would be payable by the buyer if the deal failed to close due to failed financing or due to a breach by the buyer. This limits the exposure of the buyer (and private equity fund) in such a scenario. There are also usually more limited rights to compel the buyer to close. ■ Clean Exits: Historically, especially in sales of companies by private equity sponsors, a portion of the purchase price was “escrowed” at closing to be available for post-closing claims by the buyer. Today, there is an increasing use of representation and warranty (R&W) insurance in competitive U.S. bid scenarios. This provides the seller with either a clean exit by having the insurer, rather than the seller, backstop any potential post-closing recourse, or provides it with recourse more limited than that found in a traditional indemnity. This is one area where recent trends in the U.S. have been more seller-friendly. Europe. Compared to the U.S., transaction terms in Europe typically favor the seller over the buyer. ■ Purchase Price: European transactions are commonly priced using a locked box mechanism whereby the purchase price is determined at the locked box date (which is a date before signing) based on the target’s historical balance sheet as at that date. The locked box structure offers a number of advantages primarily for sellers, particularly in terms of providing sellers with price certainty at the time of signing. Under this approach, the buyer assumes the risk of any downturn in business from the locked box date since, subject to a prohibition on “leakages” and the allowance for certain “permitted leakages”, there is no opportunity to adjust the price should the balance sheet of the target deteriorate in the period from the locked box date to closing. ■ Conditions: Once a deal is signed in Europe, there is a high degree of closing certainty as the list of closing conditions is much more limited (i.e., typically only conditions required by law or regulation, such as anti-trust clearance). There are also few, if any, termination rights which make it harder for the buyer to “walk-away” from a deal once signed. ■ Reverse Termination Fees: It is rare for European private company acquisitions to have any reverse break fees. Typically a private equity sponsor is “on the hook” for its full equity commitment if it fails to close when required. ■ Clean Exits: R&W insurance (called warranty & indemnity (W&I) insurance in Europe and Asia) is becoming more common in European deals, although it has not had as much traction as in the U.S. Having said that, if the seller is a private equity sponsor, typically the sponsor does not stand behind any of the business warranties which are provided in the purchase agreement, with management “on the hook” for a portion of their proceeds if the business warranties are breached. Asia. Deal practices in Asia tend to vary by market and both European and U.S. approaches are used. ■ Purchase Price: Locked box pricing is rarely seen in Asian deals and the use of U.S.-style “enterprise value” pricing, with closing accounts, is much more common. ■ Conditions: The degree of conditionality and closing certainty tends to vary by market in Asia and is also influenced by whether the sales process is competitive. Both the U.S. approach (more buyer-friendly with more closing conditions and less closing certainty) and the European approach (more seller-friendly with limited closing conditions and more closing certainty) can be found. ■ Reverse Termination Fees: It is rare for Asian private company acquisitions to have any reverse break fees. Sometimes transactions are done similar to the European approach with the private equity sponsor “on the hook” for its full equity commitment. ■ Clean Exits: W&I insurance is common in some markets such as Australia, and developing in others including Hong Kong and Singapore. The European-style approach with management standing behind business warranties is not seen. Global Private Equity Update Q1 2016 Weil, Gotshal & Manges LLP 3 Summary of Key Practice Differences The table below summarizes some of the key practice differences in private equity acquisitions of private companies across the U.S., Europe and Asia. Practice U.S. Europe Asia Diligence Diligence Process Diligence done almost exclusively by buyer and its advisors. Very rare for seller to provide vendor due diligence (VDD) reports. Common for seller to provide financial and legal VDD reports. VDD report providers will typically grant reliance to successful bidder and (usually) third party lenders in connection with transaction, subject to liability caps. Depends on market. Quite rare for seller to provide any VDD in many markets including Hong Kong, China and India, where process is similar to U.S. In some other markets, including Australia, VDD is sometimes (but not always) used. Purchase Price Calculation Mechanism Closing Accounts vs. “Locked Box” Price is based on enterprise value on a “cash free, debt free” basis, and set at closing based on closing accounts. Requires robust interim operating covenants to maintain the business between signing and closing. “Locked box” mechanism slowly becoming more common in U.S. as parties seek to avoid post-closing purchase price disputes. Common use of locked box mechanism which sets price at signing based on locked box date (which is a historical balance sheet date prior to signing). Economic risk and rewards are passed to buyer as of locked box date. Need covenants to ensure there is no “leakage” between locked box date and closing, subject to certain “permitted leakages” in addition to usual “gap” covenants if there is a split signing and closing. Rare to see locked box mechanism. U.S.-style closing accounts with postclosing purchase price adjustment mechanism more commonly used. Conditionality and Termination Rights Closing Certainty Buyer tends to assume full business risk at closing. There is comparatively less closing certainty at signing for seller and more termination rights for buyer to “walk-away” if certain closing conditions are not met. Buyer assumes most business risk at signing. Very high degree of closing certainty and limited set of closing conditions (i.e., typically limited to conditions required by law or regulation). Varies by market and depends if process is competitive – both U.S. and European approaches are used. Reverse Break Fee (i.e., Termination Fee Payable by Buyer) Reverse break fee if failure to close due to failed financing or breach by buyer, and limited rights to compel buyer to close. Reverse break fee typically 4% to 7% of enterprise value depending on deal size. Rare to see reverse break fees. Rare to see reverse break fees. Closing Conditions on Representations and Warranties and Covenants Closing conditions for (1) accuracy of representations and warranties at closing to a material adverse effect (MAE) standard, and (2) compliance with pre-closing covenants. No closing condition for (1) accuracy of warranties at closing, or (2) compliance with pre-closing covenants. Varies by market, but trend is generally towards closing conditions for these matters, although deals have been done without them. Financing as a Closing Condition Financing rarely a closing condition. U.S.–style financing commitments provided at signing. Financing condition is rare, instead proof of certain funds is required at signing. Financing rarely a closing condition. Financing commitments sometimes follow U.S.–style, and sometimes U.K.–style. Material Adverse Effect (MAE) MAE conditions are common. MAE conditions are very rare and MAE rarely extensively defined (excluded matters are carefully negotiated). MAE conditions common in some markets and becoming more common in others. Sometimes buyer will give up in competitive situations. Global Private Equity Update Q1 2016 Weil, Gotshal & Manges LLP 4 Practice U.S. Europe Asia Representations and Warranties Buyer-friendly vs. Seller-friendly U.S. transaction agreements provide greater representation and warranty protection for buyers. European transactions are more seller-friendly and provide less representation and warranty protection for buyers. Varies by market. Both U.S. and European practices followed. “Bring-down” of Representations and Warranties “Bring-down” (repetition) of accuracy of representations and warranties as of closing. “Bring-down” of fundamental warranties as of closing now common, but still rare for non-fundamental warranties to be repeated at closing. “Bring-down” as of closing more common, but see European approach on some deals. Damages for Breach Damages for breach are on indemnity basis, though “walk-away” deals are becoming more prevalent. Damages for breach are on contractual basis and buyer must typically prove diminution in share value. Damages for beach may be on indemnity or contractual basis; varies by market. Backing of PE Seller PE sellers typically stand behind representations through an escrow. However, use of R&W insurance is providing more PE sellers with a clean exit. PE sellers seek only to give title and capacity warranties. PE sellers typically stand behind representations, but some deals have been done with PE sellers only giving title and capacity representations. W&I insurance used in some markets to give PE sellers a clean exit. No Undisclosed Liabilities “No undisclosed liabilities” warranties are common. “No undisclosed liabilities” warranties are rare. “No undisclosed liabilities” warranties are fairly common. Anti-sandbagging Provisions Anti-sandbagging provisions (i.e., no liability if other party already had knowledge of breach) are heavily negotiated. Either anti-sandbagging provisions are included or contract is silent on this point (as case law takes the same position). Anti-sandbagging provisions are common (or contract is silent on this point). Deemed Disclosures Data room and public information not deemed part of seller’s disclosure to representations and warranties. Disclosure is limited to disclosure schedule. Data room and public information are usually deemed part of seller’s disclosure. Data room versus disclosure schedules varies by market. See both U.S. and European practices. Representation and Warranty (R&W) / Warranty and Indemnity (W&I) Insurance R&W insurance relatively common in deals involving a selling sponsor. Can depend on size of deal. W&I insurance becoming more common. W&I insurance common in some markets such as Australia, and developing in others including Hong Kong and Singapore. Limitations on its use in some emerging markets. Global Private Equity Update Q1 2016 Weil, Gotshal & Manges LLP 5 Practice U.S. Europe Asia Indemnification Cap on Liability Cap is generally 3% to 10% of purchase price. Cap is historically up to 50% of purchase price on business warranties but trend towards decreasing due to W&I insurance. For sales of PE-backed companies, cap is typically linked to a percentage (30% to 50%) of management’s post-sale proceeds (but the practice varies). Cap varies significantly by market, and can range from 5% to greater than 50% of purchase price. Deductible vs. Tipping Basket Deductible (not tipping basket) – typically 0.5% to 1% of price. Tipping basket (not deductible) – typically 0.5% to 1% of price. Tipping basket more common than deductible – typically 0.5% to 2% of price. De Minimis (Mini-Deductible) Threshold De minimis threshold practice varies. De minimis threshold common – usually increases with deal value. De minimis threshold common – usually 0.1% or less of price but can vary based on deal. Survival Period of Claims Survival of claims usually between 12 and 24 months, and often to cover one full audit period under buyer’s ownership. Sometimes longer survival for tax representations. Also longer often for title representations. Survival of claims for business warranties to cover one full audit period under the buyer’s ownership (usually between 18 and 24 months). Tax warranties survive for 3 years up to statute of limitation period. Also longer often for title warranties. Survival of claims usually between 12 to 24 months. In some markets, a longer survival for tax representations. Also longer often for title representations. Escrow Escrow is common (consistent with size of cap) and frequently the sole recourse for buyer. As R&W insurance use has increased, the use of escrows has decreased. Escrow is uncommon. Where warranties are given, seller liability kept low through use of W&I insurance. Escrow is sometimes used but not as common as in the U.S. Use of indemnification Indemnification common, but market shifting to be more seller-friendly with “no indemnity”, public-style deals. Indemnification used only for very limited uses (i.e., certain fundamental matters and a tax indemnity). Depends on the market for indemnification. Both U.S. and European approaches used. Global Private Equity Update Q1 2016 Weil, Gotshal & Manges LLP 6 Weil’s Global Private Equity Practice 20 offices worldwide, of which 16 are recognized as top tier for Private Equity by Chambers and Partners and Legal 500 Ranked Band 1 for Global Private Equity by Chambers and Partners The global private equity team acts for more than 200 private equity clients worldwide, including 70% of the top 25, as ranked by PEI 300 2015 Ranked Top 5 for Global Private Equity for the last 5 years — Bloomberg; mergermarket 33 Chambers-ranked private equity lawyers worldwide, including 10 ranked Band 1 Market Recognition Tier 1 for Private Equity in the U.S., U.K. and Asia — IFLR1000 2016 Band 1 for Private Equity Global-wide, AsiaPacific-wide, and Across Europe — Chambers Global, Chambers Asia-Pacific, Chambers Europe, Chambers UK Band 1 for Private Equity – Hong Kong — Legal 500 Asia Pacific 2016 Band 1 for Private Equity – U.K. — The Legal 500 UK 2015 Shortlisted for Business of Law Category for Developing the Global Private Equity Watch — Financial Times’ North America Innovative Lawyers Report 2015 Recipient of “Private Equity Deal of the Year” Award — China Law & Practice 2015 Private Equity Practice Group of the Year — Law360 2012 and 2014 Global Private Equity Update Q1 2016 Weil, Gotshal & Manges LLP 7 Recent Weil Representations Avolon Holdings Limited/ Cinven Partners/CVC Capital Partners/Oak Hill Capital Partners Advent International Corporation Centerbridge Partners L.P. 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If you would like more information about the contents of this issue, or about Weil’s Private Equity practice, please contact your relationship partner at Weil, or one of the authors below: Editors: Marco Compagnoni (London) Bio Page firstname.lastname@example.org +44 20 7903 1547 Doug Warner (New York) Bio Page email@example.com +1 212 310 8751 Contributing Authors: Peter Feist (New York) Bio Page firstname.lastname@example.org +1 212 310 8939 Dianna Lee (New York) Bio Page email@example.com +1 212 310 8375 Simon Lyell (London) Bio Page firstname.lastname@example.org +44 20 7903 1388 © 2016 Weil, Gotshal & Manges LLP. All rights reserved. Quotation with attribution is permitted. This publication provides general information and should not be used or taken as legal advice for specific situations that depend on the evaluation of precise factual circumstances. The views expressed in these articles reflect those of the authors and not necessarily the views of Weil, Gotshal & Manges LLP.