The American Bar Association (ABA) recently published its 2014 Canadian Private Target M&A Deal Points Study. The study was project of the Market Trends Subcommittee of the Mergers and Acquisitions Committee of the ABA and represents the third such study published by the ABA (previous studies were published in 2012 and 2010). In total, 60 acquisition agreements of private targets by public companies were analyzed, ranging in transaction value from (Canadian) $5.6 million to $5.8 billion. The 2014 study covers transactions that were signed in 2012 and 2013.
The results of this study offer valuable information and benchmarks for transactions involving a private target and provide useful comparative data points demonstrating notable trends from pervious iterations of the study as well as valuable comparisons against similar data points in the ABA’s 2013 U.S. Private Target M&A Deal Points Study.
This blog post — the first of two posts — will summarize the 2014 study’s key findings regarding financial provisions and pervasive qualifiers.
Earnout metrics and timelines remain largely deal specific
- 25% of the transactions surveyed in the 2014 study included some form of earnout mechanism, which continues an increasing trend over previous studies (in the 2012 study, 21% of deals surveyed had earnouts, and in the 2010 the figure was only 3%). Earnings based metrics (including EBITDA) were the basis for 33% of earnouts surveyed, and a further 12% of earnouts were based on the target business’ revenues. Interestingly, more than half of the earnout deals surveyed (53%) used some “other” metric (including non-financial targets) as the basis for determining the earnout.
- The length of earnout periods continues to show considerable variation between transactions. While the most common length of earn-out period was 12 months (33% of earnout transactions surveyed), 20% of earnout deals used a 36 month period, and in a further 20%, the earnout period was either 60 months or longer. Of note, in the 2014 study, no earnout periods were less than 12 months (compared to 12.5% in the 2012 study).
Buyers are reluctant to constrain their management discretion post-closing
- One of the key tensions in an earnout is the conduct of the business post-closing. Whereas the seller is usually interested in seeing the business run in a manner consistent with historical practice (to have some comfort that the buyer will not take any actions which would jeopardize the earnout), buyers generally want the freedom to run the business as they see fit after closing. To that end, relatively few of the transactions surveyed contain express provisions protecting the sellers in an earnout. Only 20% of the agreements contained a covenant to run the business consistent with past practice after closing (compared with 23% in the 2012 study), and no agreement contained a covenant to run the business to maximize the earnout post-closing (compared with 8% in the 2012 study).
- For the first time, the ABA study also included data on acceleration of earnouts upon a change of control of the purchased business. Only 7% of transactions surveyed expressly provided for an acceleration of an earnout upon a change of control. 73% did not provide for an acceleration and a further 20% were indeterminable.
- Another new data point in the 2014 study surveys whether agreements contain an express declaimer of a fiduciary relationship with respect to earnout provisions. The answer appears to be a resounding no. None of the agreements containing earnouts surveyed contained a clear, express disclaimer, 20% were indeterminable, and 80% did not contain any such disclaimer.
Post-closing adjustments remain common and use of purchase price adjustment escrows creep up
- At 73%, the prevalence of transactions containing post-closing adjustment provisions remained relatively stable in the 2014 study (2012 – 70%). The most common adjustment continued to be working capital (70% of transactions including an adjustment provision). The 2014 study showed a continuing trend towards the buyer preparing the closing balance sheet for the post-closing purchase price adjustment, with the buyer preparing the closing balance sheet in 61% of the deals studied, compared to 52% in 2012 and 29% in 2010.
- The use of a separate escrow for closing purchase price adjustments is becoming increasingly common (23% of all transactions surveyed, versus 14% in 2012 and 10% in 2010) but still remains in the minority. For the subset of transactions where there was no separate purchase price adjustment escrow (77% of all deals), 24% expressly provided for a true-up payment from the indemnity escrow, 21% did not contemplate that purchase price adjustments would be paid out of the indemnity escrow, and 56% did not contain an indemnity escrow or holdback at all.
Pervasive qualifiers – material adverse effect
MAE carve-outs are becoming more common
- Overall, 88% of the transactions studied contained a material adverse effect (MAE) definition (2012 83%, 2010 – 73%). Of the subset of deals which included an MAE concept, 77% incorporated a forward looking component into the definition (such as an event that could be reasonably expected to have an MAE). MAE definitions continue to overwhelmingly be defined without a reference to a specific dollar amount. In 2014, only 4% of deals with an MAE definition used a specific dollar amount to define materiality.
- The inclusion of carve out language in MAE clauses continues its upward trend. Of the subset of transactions with an MAE definition, fully 83% contained some form of carve out (compared with 70% in 2012 and 60% in 2010). The most common carve outs from MAE clauses related to economic conditions (95%) and industry conditions (91%). Recent trends of note were:
- An “Actions required by the agreement” MAE carve out was present in 61% of the cases, illustrating a continuing increasing trend over the previous studies (2012- 50%, 2010-33%)
- Changes in law carve outs were present in 73% of deals, a modest increase over 2012 (67%) and a significant increase over the 2010 study (44%)
- At 48%, financial market downturn carve outs were significantly less prevalent than in previous studies (2012-60%, 2010-70%).