Our fourth annual edition of the DLA Piper Global M&A Intelligence Report was published towards the end of 2018. The report analyses the key terms being used in M&A deals globally, and highlights the differences in approach in the major M&A markets in the world including Australasia. A number of New Zealand deals on which DLA Piper had a role have been analysed for the report.
Observations highlighted in the DLA Piper global merger intelligence report are summarised below.
The locked box is becoming more important worldwide as a mechanism for finalising a ‘close’ on a deal. These are widely used in Europe – and their use is growing there. But in New Zealand this useful mechanism is not yet well known.
In a locked box deal, the purchase price is fixed – payable on completion of a share sale by reference to the target’s balance sheet position (i.e. its net debt and working capital) at a point agreed in the past. (Hence the ‘locked box date’). The buyer takes the economic benefit or risk of the target from the locked box date (not from completion).
The idea derives from private equity investors who were active in global M&A deals twenty years ago. They sought ways of transacting with the aim of delivering better results for their investors. So competitive auctions became popular and the ‘locked box’ mechanism was born.
Nowadays, in Europe at least, says our global report, locked box mechanisms are common in both auction and non auction processes involving private equity and non private equity parties. In 2018, we reported a 45% increase in locked box mechanisms in private equity to trade deals.
Trade to private equity deals still use completion accounts.
In New Zealand, if a party is selling trade to private equity, there’s an opportunity to use locked box. With locked box – trade sellers get that most desirable of results – price certainty.
Around 25% of all deals analysed by DLA Piper globally had an earn-out. These were more frequent in smaller deals than larger deals (and individual sellers). They most frequently ran for two years.
In an earn out based agreement, the seller earns more if the business achieves agreed financial goals such as higher sales or earnings. Twelve month earn out periods were more common in Australasia than elsewhere (except for Europe).
Conditions of Deals
Throughout the world (unsurprisingly) the greater the size of the entity being sold, the greater the number of conditions. In the UK, only 32% of deals were conditional; whereas in Asia-Pacific 83% of deals were conditional. Common conditions in descending order were: merger control (which means that the party purchasing reviews its purchase under antitrust laws); third party consents; other regulatory approvals; shareholder approval; and employee related considerations. In New Zealand, conditions relating to OIO consent are common and often determine the timing of transactions.
Protections Between Signing and Closing the Deal
When there is a gap between the deal signing and closing, parties usually agree on conditions that must be met before the close can occur. These are known as ‘gap protections’.
‘Material Adverse Change’ – known as ‘MAC’ – is the most common protection in US and Asian-US deals. This provision contemplates a negative change in the circumstances of the entity being sold, such that the buyer can refuse to close on the deal. Material Adverse Change is an unusual condition in Australasia and Europe. Only 29% of deals in our region have this condition; and 71% do not have it.
In the Asia Pacific region (including Australasia) the mechanism used is more commonly repetition or ‘bring down’ of warranties. Seventy nine percent of deals used this mechanism if there is a delay between signing and closing. In a ‘bring down’, the warranties and statements made at the start about the sale, are repeated at the close of the deal.
Limitation of the Seller’s Liability
The use of time limits to liability and Financial Warranty Caps was also considered in the report.
Most deals had a commercial time limit of two years. As far as financial warranty caps go, most small deals outside the USA had a warranty cap of 100% of the agreed price; while mid-sized deals more frequently used caps of 20%.
The Data Room
In Europe (and now in Asia Pacific) general disclosure via a data room is standard practice. In data rooms (many of which are virtual), secure disclosure is made during due diligence.
The US is resistant to such general disclosure.
De Minimis Exclusions and Claims Thresholds
When commercial warranties are given, it is now standard practice in both Europe and Australasia to have a small claims exclusion – or ‘de minimis’. This means that claims cannot be brought against a seller unless that ‘threshold’ or basket is exceeded. A total of 67% of deals in Australasia had such small claims excluded, and the threshold as a percentage of price was less than, or equal to, 0.75% of the purchase price.
Globally, a ‘trigger’ or ‘first $ basket’ approach (where the buyer can claim back to the first dollar once the basket threshold is crossed) is chosen in 75% of deals, over an excess approach (where the buyer can only claim above such excess). A trigger was the overwhelming choice in Australasia and in the UK.
Insurance and Deals
Insurance is increasingly used in deals – including in New Zealand – especially warranty and indemnity insurance. This is a growing trend. Globally the proportion of deals incorporating an insurance product has increased every year, according to DLA Piper’s report. Moreover, the scope of risks and jurisdictions for which cover can be obtained has continued to expand.
Insurance is widely used for all seller types – from private equity deals, to corporates.
In 2017 and the first half of 2018, the number of large deals insured increased globally, including in ‘auction’ processes.
Our M&A report also reviewed – through M&A insurance advisor Howden – whether pay-outs occurred.
The insurer noted a rising trend of transactions producing a notification, led by financial warranty breaches. The Howden statistics also showed that 90% of closed notifications were paid or accepted.
Australasian deals still use restrictive covenants, such as non-compete clauses, and globally these are used in 65% of deals. Typically, Australasian clauses apply for 18 months to three years.
The Courts were still seen as the favoured forum for disputes in Australasia (93% of disputes). In contrast, arbitration is used widely in Continental Europe.