On December 23, 2009, the American Bar Association (the “ABA”) published the 2009 Private Target Mergers and Acquisitions Deal Point Study1, its latest analysis of the principal terms and conditions of acquisition agreements of private targets by public companies. The study analyses the terms and conditions of transactions completed in 2008 in the U.S. (the study will hereinafter be referred to, as the “2008 U.S. Study”) The ABA had conducted similar studies for U.S. transactions completed in 2004 and 2006 and a comparable analysis of Canadian transactions completed in 2005 - 2006.

These publications provide a wealth of fascinating information for M&A practitioners; they have been widely disseminated and regularly influence ongoing acquisition negotiations.

The objective of this note is to highlight significant changes between the study of American transactions in 2006 and in 2008 and to discuss new issues which were tackled by the 2008 U.S. Study. It also reviews some of the interesting differences between the U.S. and Canadian practices.

The full text of the studies can be obtained from the ABA or by sending a request to Diane Bertrand at dbertrand@fasken.com.

Highlights of the 2008 U.S. Study

Overview

Overall, there are few major differences between the 2008 U.S. Study and the previous American study. The burgeoning recession does seem to have triggered significant changes in industry practices. What the 2008 U.S. Study demonstrates is greater caution on the part of purchasers by tightening of existing practices (for instance, increased use of carve outs to indemnification limitations). However, the M&A practice in 2008 in the U.S. did not reveal fundamental changes in attitudes that a full blown recession would be expected to have (such as, for example, greater use of earnout provisions).

The 2008 U.S. Study also examined a few deal points not previously analysed which bring additional depth to this already comprehensive study of M&A practice in the U.S.  

Context  

  • In 2008, the U.S. experienced the beginning of an economic recession; previous ABA studies were conducted in economic environments experiencing significant GDP growth (3.5% in 2004 and 2.7% in 2006)2.  

Post closing adjustments to purchase price

  • More transactions contained adjustment provisions (from 68% to 79%);  
  • the pre-dominance of the working cap adjustment increased (77% instead of 69%);  
  • for most transactions, the working cap adjustment is the sole adjustment but there is an increase in the use of 2 or more adjustments (from 29% to 38%);  
  • increase in adjustments provisions based on debt (from 20% to 29%) and cash (from 13% to 19%) and decrease in adjustments based on assets (from 15% to 6%) and earnings (from 4% to 2%);  
  • (New!)3 in about 15% of the transactions containing a working cap adjustments, the definition of “working cap” excluded current tax assets and current tax liabilities;  
  • small increase in the rare practice of applying a threshold to the payment of post closing adjustments (from 10% to 15%);  
  • increase in the use of earnouts provisions but the practice is still limited (from 19% to 29%s);
  • earnouts are still most commonly based on earnings (32%) and revenues (29%) but it is quite frequent to use some kind of operational milestone (26%);
  • (New!) length of the earnout period: more than half of earnout adjustments cover a period of 2 years or less (52.1%) but a significant number of earnout provisions last more than five years (8.7% of transactions with earnouts);
  • important increase in the number of transactions which provide for the acceleration of the payment of the earnout upon a change of control of the target (from 11% to 33%);
  • (New!) there is a small trend to include provisions that specify that (i) the earnout is not an “ownership interest” of the seller and (ii) it does not create a fiduciary duty for the purchaser (6% in both cases).

Covenants

  • (New!) There is normally a duty to update the representations and warranties up to closing (69%); interestingly, the study finds that in 81% of the transactions, the purchaser’s right to indemnification is not limited for updated matters;
  • (New!) most transactions include an exclusivity provision (86%).

Representations and warranties

  • Increase in the rare practice of requesting a confirmation at closing that the representations formulated at signing were true in all respects (i.e. without a qualifier) (from 2% to 8%);
  • representations still generally last 18 months in the U.S.; however, more transactions use an 18- month period (from 34% to 38%) or between 12 to 18 months (from 9% to 12%) and less transactions use a 12-month period (from 26% to 20%);
  • the same issues are being carved out of the survival limitations as in previous studies but there is a general trend to carve issues out more often.

Legal opinion

  • Decrease in the requirement to deliver legal opinion of target’s counsel at closing (from 70% to 58%)4.

Merger deals

  • (New!) 57% of transactions include a condition based on appraisal rights (known as “dissent rights” in Canada); generally the condition states that closing may not occur if a certain percentage of holders exercise their appraisal right.

Indemnification

  • Slight change in the value of the basket: the majority of transactions used to set the basket value below 0.5% of the transaction value (62%); now, the basket is as likely to be below 0.5% (44%) as between 0.5% and 1% (45%);
  • it is becoming more common to carve issues out of the basket;
  • slight increase in the practice of identifying a $ threshold per claim (it is still a fairly rare practice) (from 18% to 23%);
  • having an indemnification cap lower than the purchase price is still a strong practice (86% of transactions have a cap lower than a purchase price); 78% of the transactions have an indemnification cap below 25% of the purchase price; only in 4% of the transactions is the cap equal to the purchase price;
  • it is becoming more common to carve issues out of the indemnification cap;
  • increase in the number of transactions which use indemnification as the exclusive remedy (from 77% to 85%);
  • slight decrease in transactions which include an escrow (from 89% to 81%); fairly often, it is the exclusive remedy (33% of transactions);
  • the escrow value is still normally between 7% and 15% of the purchase price (59%), but more transactions have a 7% to 10% escrow (from 14% to 27%) and less transactions are below 7% (from 38% to 26%).

Dispute resolutions

  • Slight increase in use of mediation or arbitration mechanisms (from 31% to 35%) but there is a decreased interest in using mediation then binding arbitration (from 18% to 3%).

Comparing U.S. and Canadian practices

The following table is based on the 2008 U.S. Study and the similar ABA study conducted on Canadian transactions implemented 2005 and 20065. It highlights major trends and differences between the U.S. and Canadian M&A practice. Note that only selected results from both studies are shown below and, generally, only the most frequent options have been retained. The reader should refer to the actual studies for a more complete comparative study.

Please click here to view table.