The M&A Market Trends Subcommittee of the ABA’s Business Law Section recently released its US Private Target M&A Deal Points study which analyzed publicly available acquisition agreements which were signed or completed in 2020 and Q1 2021 in the US. The sampling covered 123 deals with transaction values ranging from $30M to $750M, with the top 3 industries being health care, technology and industrial goods & services. Key findings of the study are as follows:
- Tempered Use of Earnouts? Perhaps surprisingly given the ongoing pandemic and challenges associated with valuations during such unprecedented times, only 20% of deals in 2020 and 2021 contained earnout clauses (compared to 27% in 2018-2019 period), with the most popular benchmark used to calculate the earnout being revenue. The revenue benchmark increased significantly from previous years and was notably ahead of any other measuring stick. The EBITDA benchmark correspondingly decreased in popularity in 2020 and 2021 and was found in only 11% of deals with earnout clauses. 79% of deals with earnouts did not contain a covenant of the buyer to run the business consistent with past practice – this is fairly stable with all of the prior years analyzed. That said, a relatively large change from previous years was the finding that 92% of deals did not include a covenant of the buyer to run the business to maximize the earnout (compared to 76% of deals in 2018 and 2019). Finally, north of 80% of the earnout provisions did not contain a stand-alone covenant to run the business as a stand-alone entity during the earnout period. These statistics are somewhat surprising given the “seller’s friendly” deal environment we’ve been seeing.
- Breaking Up is Hard to Do.New data was included in this year’s study, tracking the use of termination fees, which were identified in 22% of the deals analysed. In respect of deals that included termination fees, buyers were on the hook to pay the fee 70% of the time. The median termination fee payable by the buyers was 4.62% of the transaction value.
- Covid Carve Outs.In respect of deals that included carve outs to the “Material Adverse Effect” definition, 67% excluded the effects of a pandemic from the definition. This finding suggests that the majority of buyers are accepting the fact that the COVID-19 pandemic may have an effect on the seller’s business between signing and closing, and any such effect (even if it otherwise would meet the threshold of an MAE) cannot entitle them to walk away from the deal.This coincides with the finding that 45% of deals that included a seller covenant to operate the business in the ordinary course between signing and closing included an exception to this covenant for actions taken in response to COVID-19.
- #metoo Representation.37% of deals in 2020 and 2021 contained a specific representation with respect to the target being involved in sexual harassment or misconduct allegations or settlements, up significantly from 13% of deals in 2018 and 2019, when this representation made its first appearance.
- Survival Time. With respect to the survival of representations and warranties, 33% of deals in 2020 and 2021 had no express survival period (likely an ode to the increasing popularity of representations and warranties insurance or RWI), while 43% of deals had 12 month survival periods and 37% had 18 month survival periods. Only 5% of deals in 2020-2021 had survival periods of 24 months.
- Taking Control. Another sticking point for buyers and sellers is control of the defense for third party claims. If you are the indemnifying party (typically the seller), should you be allowed to assume the defence of such third party claim? In 94% of deals in 2020 and 2021, the indemnifying party was allowed to assume the defense of third party claims, up from 85% in 2018 and 2019. In 61% of deals the indemnifying party did not have to acknowledge liability prior to doing so.
- RWI Trends. 65% of deals in 2020 and 2021 referenced RWI (up from 52% in 2018 and 2019 and up from 29% in deals in 2016 and 2017). In terms of sole recourse, 38% of the time the buyer’s sole source of recovery was RWI for all reps and 25% of the time RWI was the buyer’s sole source of recovery for non-fundamental reps. Baskets are lower (under 0.5% of the transaction value) where RWI is at play. Caps have continued to decline. It’s apparent that RWI has been on the rise in recent years. So much so, that we wonder if the sample size shouldn’t be split in coming years to separate studies for RWI and non-RWI deals to provide more meaningful data.
- It’s a Seller’s Market.A trend in many of the findings from the survey suggests that sellers continue to hold the upper hand (or bargaining power) when it comes to negotiating M&A transactions. For example, nearly 40% of in deals providing for a distinct adjustment escrow provide that the escrow is the sole recourse for downward purchase price adjustments (up from 26% of deals in 2018 and 2019). In addition, the bring down threshold for representations and warranties is now the MAE standard (as opposed to materiality) in over 75% of deals (up from 67% in 2018 and 2019). This seller friendly trend is perhaps not surprising given low interest rates and abundant capital in search of targets.
Notwithstanding the importance of the study, readers should be mindful of the nature of the sample used in this study. The agreements reviewed are only publicly available acquisition agreements which involved private corporations being acquired by a public corporation (for which the transaction was material enough to be disclosed publicly). Consequently, the review sample may not always correctly represent the current market.
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