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Key Takeaways from SRS Acquiom’s 2020 M&A Deal Terms Study

Fasken
Reading Time 6 minute read
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Corporate/Commercial Bulletin

The 2020 M&A Deal Terms Study published by SRS Acquiom on May 5, 2020  provides an overview of market trends based on an analysis of over 1,200 of their private-target M&A transactions which closed between 2015 and 2019. The vast majority of this sample involved U.S. public and private buyers, and ranged in transaction size from US$25 million to US$250 million. Here is our selection of their key findings:

Numbers: Is it All Downhill From Here?: 2019 appears to have been a year of slight decline. The median amount of equity capital invested dropped to $27 million (down from $31 million in 2018) and the median multiple return on investment declined to 3.4x (down from 3.8x in 2018, and down even further from 4x in 2017). This may be linked to 2019's shorter median amount of time from first investment round to exit (6 years), as well as a smaller number of average equity financing rounds (3).

• Broaden Your Knowledge!: 93% of M&A transactions make use of the concept of "constructive" knowledge, as opposed to relying on the "actual" knowledge of one or more persons. Furthermore, it seems that the notion of constructive knowledge is increasingly being based upon the knowledge of "the company" as a whole, rather than on an obligation of the seller to inquire with specific key members of the company's personnel.

• How Much Do I Really Have to Disclose?: Parties seem to be taking an increasingly hard line as regards their respective duties to disclose or to notify the other party of known breaches or inaccuracies in representations and warranties. In 2019, parties were less likely to include an express duty to notify the buyer of a pre-closing breach of representations and warranties (61% compared to 70% in 2018). Furthermore, 54% of deals contained a pro-sandbagging provision, remaining consistent with trends in U.S. M&A transactions over the past few years. Therefore, in most of the deals analysed, sellers have no obligation to inform buyers of known breaches or inaccuracies in their representations and warranties and what's more, they are expressly permitted to close the deal and then sue on exactly that basis. We  note that such clauses tend to be less popular in Canada, and particularly in Quebec, possibly due to the civil law's emphasis on good faith in contractual negotiations.

• And How Accurate Do I Really Have to Be? In terms of how accurate a seller's representations must be in the context of two-step transactions, only a small percentage of deals (less than 5%) in 2018 and 2019 made use of the onerous "in all respects" standard. The "in all material respects" standard continues to be the most popular, appearing in over 50% of deals in both 2018 and 2019. But a new trend is on the rise. The "Material Adverse Effects" formulation (requiring accuracy in all respects, except to the extent that inaccuracies do not and could not reasonably be expected to have a Material Adverse Effect) has been steadily gaining ground, increasing to 44% in "at signing" clauses and to 48% in "at closing" clauses. That said, in deals with materiality or Material Adverse Effects qualifiers in the "accuracy of representations" condition, those clauses are most often (approximately 90% of the time) accompanied by a materiality scrape, providing that such qualifiers are to be disregarded for the purposes of determining accuracy of the representations and warranties.

• …Speaking of Scrapes: Materiality scrapes are a contractual feature that typically favour the buyer, and which are included to remove any materiality qualifiers built-in to representations and warranties for indemnification purposes. Inclusion of materiality scrapes in purchase agreements for determining both breach and damages was included 60% of the time in 2019, a notable jump from 48% in 2018. So just in case you thought that emerging trends in M&A transactions were looking a little too seller-friendly, take comfort in the fact that we are seeing the opposite here.

• Indemnification: Getting Exclusive: Indemnification as the exclusive remedy for breach continues to be a major trend in M&A transactions. Indemnification was specifically stated to be the exclusive remedy in 96% of deals (with 2% being silent, and only 2% providing for some alternative remedy). Carveouts to this exclusive remedy are also increasingly few and far between. While equitable remedies and fraud are commonly carved out, intentional misrepresentation is carved out only 25% of the time, and wilful breach of covenants is carved out only 9% of time (a significant decline from 14% in 2018. In this optic, the negotiation of the indemnity escrow takes on increased significance. The median general survival period for indemnity escrows remains 15 months, and the median escrow size was 9.9% of the transaction value (10.5% for deals with no representations and warranties insurance) - in both cases, a slight but not marked increase from the 2018 numbers.

• Bye Bye Baskets: Perhaps precisely because of how often indemnification is limited to the "four corners of the agreement", baskets seem to be dropping in popularity. For the first time since 2015, 10% of M&A transactions had no baskets (up from a low of 4% in 2017). In deals that do have baskets, the "first dollar" or threshold formulation remains only slightly more popular than the "deductible" formulation. In addition, the size of the basket as a percentage of transaction value is decreasing rapidly - in 2019, almost 60% are set at 0.5% or less. Common carveouts to baskets in 2019 included capitalization (87%), due authority (86%), due organization (84%), ownership of shares (81%), taxes (77%), broker and finder fees (77%), and fraud (75%).

• Cutting Caps: 2019 has also seen a decrease in the amount of caps on indemnification as a percentage of transaction value. The median cap for all deals for 2019 was 10% of transaction value. This can be partly attributed to the increasing popularity of representations and warranties insurance, which generally results in a smaller liability cap. When reps and warranties insured deals are removed from the data set, the median cap rose to 10.7% of transaction value. 2019 also saw a notable rise in the number of deals capped at the purchase price (5%, up from just 1% in the two preceding years). Common carveouts to caps in 2019 included fraud (87%), capitalization (84%), due authority (83%), due organization (81%), ownership of shares (80%), taxes (78%), and broker and finder fees (74%).

• Standing Alone: In 2019, the following standalone indemnities were found in more than half of all M&A transactions: taxes (85%), accuracy of closing certificates (75%), capitalization (74%), litigation (67%), transaction expenses (60%), and payments to dissenting shareholders (56%). The next most common (both at 44%) were for fraud and wilful misrepresentation and purchase price adjustments.

• Resolving Disputes the Old Fashioned Way: There has been a steady decline in the number of M&A transactions that include alternative dispute resolution ("ADR") clauses. In 2019, only 18.1% of deals contained an ADR clause, compared to an all-time high of 28% several years ago. For those deals that did provide for some form of ADR, there was a marked increase in the number of agreements providing that the fees are to be paid by the losing party.

• Breaking Up with Breakup Fees: There has also been a steady decline in the number of deals that include termination or "break up" fees. That number is down to just 12% in 2019. In those few deals that do contain termination fees, 2019 has also seen a drop in the median fee payable by both buyers and sellers. So in the end, breaking up is not that hard to do.

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