Reduced availability of acquisition financing in the United States over the past couple of years has led to a rise in the use of alternative structuring tools to bridge the gap. Specifically, the following structural alternatives have been included in a number of recent deals and signal a trend, at least for the near term, in the way private M&A deals are being structured and negotiated.
Recently, there has been a significant rise in the number of M&A transactions that have included an “equity rollover” component. In an equity rollover, the seller retains an equity interest in the target, which typically is structured as an exchange by the seller of a portion of its equity for common or preferred stock of the buyer; this results in a dollar-for-dollar reduction in the cash purchase price payable by the buyer. Recent transactions have seen rollovers of 10% and higher of the value of the target. On January 15, 2010, for example, a joint venture comprising Emeritus Corporation, an affiliate of Blackstone Advisors, and CPDF II announced that it had entered into a purchase and sale agreement to purchase a portfolio of properties constituting the Unitary Sunwest Enterprise (Sunwest) for an aggregate purchase price of $1.15 billion. Under the purchase and sale agreement, approximately $235 million (representing the cash/equity portion of the purchase price) may be reduced by a potential equity rollover of up to $25 million by the existing Sunwest investors. The primary issues associated with equity rollovers include reaching agreement on the rights and obligations of the seller’s minority interest in the target business.
Another tool that sellers have been using to bridge the buyer financing gap is seller financing. In situations in which the buyer will require additional financing, the negotiation of seller financing can be challenging. The senior bank facility usually sets the stage for what is possible with respect to mezzanine and seller financing. Key negotiating points usually include discussion of limits on covenants and the right of the seller to accelerate in the event of a default (e.g., how deeply subordinated the seller’s paper will be), the ability to pay PIK (payment-in-kind) interest in the form of additional securities and the maturity date. Late last year, Barnes & Noble, Inc. (B&N) completed its acquisition of privately held Barnes & Noble College Booksellers, Inc. for approximately $600 million. In addition to financing $150 million of the purchase price under a new $1 billion, four-year revolving credit facility, B&N used cash on hand and $250 million of seller financing to complete the transaction.
The earnout, which is another tried-and-true tool for bridging the financing gap, is contingent consideration payable to the seller on the basis of the target’s post-closing performance. During the 2007-2009 “Great Recession,” earnouts also increased in popularity as a means of bridging the valuation gap between buyers and sellers who frequently could not agree on the future performance of a target. In a recent merger transaction, for example, the acquiring company, United Refining Energy Corp. (URE), agreed to issue 51.5 million shares of its common stock at closing to the stockholders of Chapparal Energy, Inc. URE also agreed to issue an additional 10 million shares of common stock (the escrow stock) to an escrow account at closing. Under the merger agreement, the escrow stock is to be released from escrow and delivered to Chapparal stockholders if an agreed share price target is met by the sixth anniversary of the closing. Although earnouts such as the one in the proposed URE merger with Chapparal tend to be conceptually simple, they are difficult to negotiate and frequently are of limited utility. For example, onehalf of the escrow stock in that merger also is available to URE to cover Chapparal’s indemnification obligations. Buyers and sellers frequently have difficulty agreeing on the metrics on which the earnout is to be paid, and often get embroiled in post-closing disagreements over whether thresholds triggering earnout payments have been met, especially when the post-closing earnout period extends for several years.
There has also been a rise recently in the use of financing and financing-related conditions, including the “funding condition,” the “financing-conditions condition” and the “financial metrics condition.” The funding condition, which has enjoyed wide use for decades, provides that a buyer can refuse to close unless it obtains financing, and is usually coupled with a commitment by the buyer to use reasonable commercial or best efforts to obtain the funds on terms that are not worse than a bank commitment furnished at the time the purchase and sale agreement is executed. A recent variation to this approach would permit a buyer to walk away from the deal unless all the conditions of the buyer financing, as set out in a debt commitment letter attached to the transaction agreement, are met. Under this financingconditions condition, if those conditions are satisfied, the buyer bears the risk of a bank default. Another variation of the financing condition is the financial metrics condition, which has also been used for a long time and provides a walk-away right for the buyer if the seller does not meet one or more financial metrics at closing, such as a specified minimum threshold with respect to net indebtedness or working capital. Although more common in privately negotiated transactions, the financial metrics condition is also used in public transactions. IESI-BFC Ltd. recently included such a closing condition in its merger agreement with Waste Services, Inc.