At Reed Smith’s London Corporate Forum, which took place last week, Doug Rofé highlighted legal trends that we are currently seeing in the private M&A market. In this article, we summarise those top trends and discuss what is becoming market-standard when negotiating private M&A deals.
More deals are conditional
In an increasingly regulated environment, the need to obtain antitrust, regulatory and other approvals and clearances such as change of control approvals is becoming more common. The process of obtaining such consent normally results in there being a gap between signing and completion; this can add to the negotiation process and the length of the sale agreement. When drafting a deal with a gap between signing and completion, the parties will need to agree how the business will be operated during this period and what warranties will be repeated at completion.
More auction sales
We are seeing an increase in the number of transactions that take place by way of an auction sale. While auction sales can allow sellers to achieve higher prices, they involve more work and can be very burdensome for any unsuccessful bidders.
In our experience, auction sales are no longer restricted to just large deals.
More partial acquisitions
We are also seeing more partial acquisitions of target companies not only by private equity investors but also corporate investors. In the case of corporate investors, this is often accompanied by an option (such as a put and call option) to acquire the remaining shares in the target company at a later date.
A seller’s market?
Our conversations with key people in the market suggest that, over the last 12 months or so, we have been operating in what is becoming an increasingly seller-friendly market and that this is being reflected in the deal terms, for example:
- the typical financial cap on the seller’s liability is falling and warranty limitation periods are becoming shorter;
- buyers are more willing to accept full disclosure of the data room;
- material adverse change clauses (which are used when there is a gap between signing and completion) are becoming less common (although they are still regularly used in the United States); and
- fewer escrows are used as security for warranties (this could in part be due to the increase in warranty and indemnity insurance).
The rise of the locked box mechanism
More deals now include a price adjustment mechanism. While completion accounts are still the most commonly used mechanism, locked box accounts are gaining ground.
Buyers traditionally favour completion accounts. Completion accounts involve drawing up accounts after completion to determine the value of the net assets or working capital of the target as at completion and, once determined, adjusting the purchase price accordingly. In the United States locked box accounts are still very rarely used.
Conversely, locked box accounts are often considered to be more seller-friendly. Using the locked box mechanism, the buyer values the target company by reference to an agreed set of accounts drawn up to a date prior to completion and the seller then agrees to indemnify the buyer for any unauthorised leakage of value between the date of those accounts and completion. Buyers are becoming more comfortable with using the locked box mechanism and they are now used in most private equity deals.
Changing warranty limitations
Warranty limitations are generally becoming more seller-friendly. As highlighted below, this is particularly true with respect to the overall liability cap and time limits:
- Overall liability cap: There is almost invariably a cap on the seller’s overall maximum liability under the warranties and possibly other provisions of the agreement such as those relating to tax or other indemnities. A decade or so ago, it was standard to have a cap equal to 100 per cent of the purchase price. Nowadays, the average financial cap in the UK is closer to 50 per cent of the purchase price (with most deals being in the 25 per cent to 75 per cent range). In this regard, we are becoming more like the United States, where financial caps are typically much lower.
- Time limits: Any warranty claims have to be made within the agreed time limit. Traditionally, for non-tax claims, this was set at between one and three years. In recent years, this period has been reduced and is now normally in the one to two year range. For tax claims, the norm remains seven years for UK targets, although buyers are increasingly willing to agree shorter periods.
Bucking this trend is the basket, which we think is becoming slightly more buyer-friendly. The basket is a monetary threshold which must be exceeded before any claims can be brought by a buyer. The level of the basket is typically set at 1 per cent to 2 per cent. In the UK, it is almost universally agreed that once the basket threshold is reached the buyer can claim for all loss suffered and not just for the excess.
To complete the picture, the other limit that is often talked about is the de minimis limit. Most sale agreements in the UK and Europe contain such a limit and all warranty claims below this limit are completely disregarded. The de minimis limit is typically set at somewhere around 0.1 per cent of the purchase price. This limit has not changed much in recent times. Although most U.S. deals still do not contain a de minimis limit, it is becoming more common there.