During the past three years there has been a steadily increasing amount of money chasing a decreasing number of deals, as the graph below highlights. This, combined with readily available debt finance (despite the current lack of clarity on pricing and certain deal terms in the debt market), makes for a very competitive European M&A market, a dynamic supported by recent research Latham & Watkins undertook into European private M&A deal terms.
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After the financial crisis there was a view that private equity buyers would exercise greater caution than during the boom years and, indeed, that this would be a requirement of their debt providers. At that time it was true that there was a renewed focus on contractual protections in sale and purchase agreements, such as material adverse change (MAC) conditions giving buyers the right to withdraw from acquisitions, or escrows and deferred consideration, giving buyers some protection over what they ultimately paid for a target business post-closing of a deal. However, these deal protections did not catch-on in any significant way, perhaps surprisingly given the economic environment, and the clear market practice in the US, where such provisions were — and continue to be — common place. As our deal terms research illustrates, in recent times there has been a shift back towards the pre-financial crisis years of super seller friendly transaction terms.
Locked box purchase price mechanisms, aimed at allowing a buyer no ability to challenge the price it has paid for a business post-closing based on the balance sheet determined on closing, are now the default starting point for private equity transactions. The vast majority of deals signed from 2012 onwards involving a private equity seller or buyer were transacted on the basis of a locked box, and it appears clear that there now needs to be a good reason to move away from the locked box standard when transacting with private equity counterparts. Similarly, and as before the financial crisis, it is extremely uncommon for there to be a MAC condition in sale and purchase agreements or even the ability to terminate the purchase for a material breach of contract by the seller between signing and closing of the transaction. Escrows, deferred consideration and earn-outs are also rarely seen. Before sellers get too excited, the research findings also show that in deals involving less appealing assets, or very “hairy” businesses, there is a more cautious approach, and it tends to be on these deals that MAC conditions, retentions and increased warranty coverage are used.
At Latham, we think there’s a pattern emerging and we’re starting to see the development of a two-speed market between the hot and the not-so-hot assets. That’s one to keep an eye on, particularly in the current market where the quality of the borrower group is key, but for the time being the majority of the evidence suggests that the current trend is for super seller friendly sale and purchase agreements and absent some sort of significant market MAC, we see no reason why this trend should reverse any time soon.