Matthew S. McElhiney
Determining recent trends in merger and acquisition transactions can be a powerful tool when negotiating deal terms involving the purchase or sale of a business. Although the terms of most purchase and sale transactions between private parties remain confidential, many publicly traded companies report the terms of their purchase and sale agreements after they have closed upon the purchase or sale of a business. Since 2010, the terms of dozens of purchase and sale agreements have been reported to the Securities and Exchange Commission. The terms of those agreements reveal very interesting and notable trends that are valuable for any business purchaser or seller to be aware of.
In almost all cases, deals were placed under contract and closed at a later date after an extended due diligence period. The use of “sign and close” agreements, where a purchase and sale agreement is signed and the deal closed at the same time, has become more rare in recent years.
Consistent with past practice, the vast majority of reported deals involved asset (rather than equity) purchases. Buyers typically favor asset acquisitions – to avoid the assumption of seller liabilities – which is the common result of a stock or equity deal.
Roughly 90% of the reported deals involved some kind of purchase price adjustment post-closing, while only about 25% involved a post-closing earn-out as part of the consideration paid to seller. Despite tough economic conditions during the reporting period involved, almost 75% of reported deals were cash transactions, which did not involve a buyer paying all or a portion of the purchase price in the form of a promissory note or an ongoing equity interest in the acquiring, or an affiliated, entity. To sellers, cash has always been king, but that sentiment seems to have increased in significance during tough economic times.
Roughly 60% of reported deals did not involve a seller escrow or purchase price holdback. In the roughly 40% of deals involving a seller escrow, escrowed funds typically ranged between 4% and 12% of the overall deal value. Escrow periods typically ranged between 6 and 24 months after the closing date. Escrow holdbacks were usually retained to be offset against Sellers’ indemnification obligations (in order for the Seller to stand behind the warranties and representations made to the Buyer in the purchase agreement) and to cover any post-closing purchase price adjustments negotiated between the parties.
Post-closing purchase price adjustments were commonly used in the vast majority of deals. The purpose of the purchase price adjustments were usually to allow buyers, post-closing, to determine the actual amount of working capital (i.e. some derivation of short term assets less short term liabilities), accounts receivable or actually collectible, or inventory to be determined with greater accuracy post-closing – after the buyer took possession and control of the business and could more readily determine and verify balances set forth on seller financial statements.
In the limited number of deals where earn-outs were used, the amount of the earn-out was usually capped, based upon some metric for future earnings or performance figures of the acquired business. Where used, earn-outs were typically paid for a one to three year period after closing. Most interestingly, as often as not, earn-outs were payable in the form of an equity interest in the purchasing entity as opposed to cash – indicating that earn-out consideration likely involves much less liquidity or certainty for a seller than receiving cash in-hand at closing.
“No-shop,” or exclusive dealing covenants, were almost universally used, rather than agreements allowing a seller to “shop” a deal after a purchase agreement was signed – and to pay a “break-up fee” if the seller later found another suitor to whom they would rather sell their business. Legal opinions were only required in about 20% of the transactions, likely indicating a preference to reduce transaction costs, rather than the buyer receiving additional assurances from seller’s counsel at closing. Financing contingencies appear to have gone by the wayside during recent years – only having been used in one reported transaction reviewed for this article!! The message to buyers seems clear – have cash in-hand to complete your purchase, or have firm financing in place prior to entering into a purchase agreement – or the seller may not take your overtures to purchase their business very seriously.
The trends identified herein are admittedly from larger deals (from about $20 to $350 million in size) that were closed by publicly traded companies between 2010 and early 2012. Obviously, every deal is different, and smaller deals involving privately held companies may or may not mimic these trends. Nevertheless, being represented in your M&A transaction by an experienced business broker and legal counsel, who have familiarity with current market trends and regularly engage in M&A transactions, can be invaluable to your deal. And educating yourself as to ongoing market trends will almost always serve to increase the odds of reaching your goals in your business purchase or sale transaction!!
(originally published in the May 2012 eNewsletter)
Mr. McElhiney is a transactional attorney at Kutak Rock LLP in Denver, Colorado, practicing in the merger and acquisition area. He can be reached at 303-292-7739.