June 28, 2023
One of the superior benefits to membership in the IVCA is the event Education Luncheons that are presented by the association and the sponsoring partners. Cooley LLP sponsored the topic “2023 M&A Deal Terms Study – How It Relates To Your Business” on May 25th, and it highlighted some key takeaways from a 2023 M&A Deal Terms Study conducted by new IVCA member SRS Acquiom.
The Study presents an analysis of more than 2,100 private-target M&A industry acquisitions valued at more than $460 billion, that closed between 2017 and 2022 … with most of these M&A deals not required to be publicly reported. The Study highlights were presented by Eric Martin of SRS Acquiom, and he was joined for analysis by Erin Kirchner and Kester Spindler of Cooley LLP. The following are a few of the informational highlights of the presentation.
SRS Acquiom was founded in 2007 by Paul Koenig, Mark Vogel and Jason Mendelson in Denver. To untangle the complexities of the M&A deal execution process, the firm provides an integrated platform of professional services, technology solutions and data that enables corporate acquirers, Private Equity firms and Venture Capital firms to navigate those processes. Some of the issues in those processes were discussed in the specifics presented at the Luncheon.
Most deals around the founding of SRS were all cash, now 22% involve stock transactions. Erin Kirchner noted the trend in VC deals, as buyers are preserving cash. Eric Martin added that valuation on stock was very important in paying for post closing claims. One question that comes up … Are stock values associated with true value or post closing values?
The concept of Management Carve-Outs is when the transaction proceeds are not enough to payout all the common stockholders, which is usually the class of stock or options the management holds, so a “carve-out” for management is done to reward them anyway, and it’s became a popular tenet when overall valuations suffered, but they have plummeted as valuations rose in the last decade. Ms. Kirchner observed that these carve-outs are becoming less apparent because of shareholder litigation.
What is meant by that is a deal structure where some portion of the deal consideration is targeted by the buyer for the seller to meet certain objectives. This is popular in the bio-pharma, for example a drug asset will be bought for a certain amount, and as that asset advances through the various milestones … approvals, trials, etc. … those are the moments in which the buyers will pay the sellers the next installment of the overall proceeds, and it can last for years in life science deals. Through the experiences of Kester Spindler and Ms. Kirchner, these earnouts have to be narrowly defined, as they make up the bulk of post-deal litigation. Buyers are also demanding more provisions on earnout definitions.
Two-thirds of deals use top line revenue to define whether or not it made the target at closing. It is a more secular number, since revenue is a status that can be figured out. Earnings and EBITA are potentially more complicated, there are many new things that go into that math. Clarity is power.
This is regarding the percentage of value earnings through the last decade, on a steady decline until COVID, where several factors doubled the percentage. It has since leveled off. Ms. Kirchner remarked that deals are trying to bridge gaps in valuation, to the point that a seller just comes to a certainty. This metric becomes important because it spotlights numbers that both buyers and sellers can indicate.
Whether or not there is a covenant for a buyer to run a business in accordance with the seller’s past practices. The percentage swayed toward buyer change, although surprisingly 23% had covenants.
ACCELERATION IN CHANGE OF CONTROL
An approximate 70-30 split favoring not going to accelerate the change of control to the buyer at closing.
Most deals (73%), when the buyer can offset indemnity claims, the seller agrees that a payment can be lower to offset those claims.
Across all deals about 12% of buyers agree to pay a termination fee, but it’s mostly in Private Equity … just taking PE into consideration, the percentage jumps to 25%. Mr. Spindler remarked that he doesn’t see a lot of termination fees in his world, but there are also reverse termination fees for protecting Private Equity in the process.
How a deal closes based on how the seller ownership is structured within the transaction … between outright/individual owners, stockholders and other considerations or shares. Shareholder representatives can be involved.
Seller usually puts funds aside for expenses like shareholder representatives and other third party extensions (accountants, lawyers). There are estimates on the range of how much those funds can be versus the size of the deal, but it doesn’t necessarily go up as the final purchase numbers go up. Also deal structure is a consideration, those with earnouts have larger funds, for example. Excess from these funds are returned to the seller after closing, based to what extent they were used.
REP & WARRANTY INSURANCE
It’s is the type of insurance policy purchased in connection with corporate transactions, and covers the indemnification for certain breaches of the representations and warranties in the transaction agreements. Most deals in the story (88%) didn’t have it, but in a robust selling market it increases, especially in Private Equity. Mr. Spindler sees the trend toward R&W insurance declining, with buyers going back toward indemnification packages and escrow. Ms. Kirchner remarked that in competitive auction environments there is more R&W insurance is more prevalent. As those situations are declining, the use of the insurance follows that decline.
POST CLOSING CLAIM ACTIVITIES
As examples, breach of rep warranty, recovery of fees and costs, sales or income taxes and capitalization claims. Half are 150K and less. One in three deals with R&W Insurance will file a claim.