Drawing on Latham’s Sixth Private M&A Market Study, we explore trends and developments in consideration mechanics and deal conditionality.
Uncertainty has been a significant market factor in 2019. The UK’s decision to leave the European Union, protectionist responses to China as a global investor, market volatility, and trade tensions have all given dealmakers pause for thought. With these growing pressures on international M&A, deal teams and in-house counsel are increasingly required to work with advisors to find strategies and solutions to get deals done — a task that requires an intimate knowledge of deal terms and current market trends. In our view, geopolitical factors can impact how parties approach deal architecture and key provisions of transaction documents.
Drawing on data from Latham & Watkins’ sixth Private M&A Market Study, we will examine how consideration mechanics and conditionality deal terms are responding to the current M&A market.
Seller-Friendly Market and Seller Demographics Impact Choice of Consideration Mechanics
Our analysis of 240 European deals signed between July 2017 and June 2019 shows that as many as 50% of European deals include a locked box mechanism, demonstrating that Europe continues to offer a seller-friendly M&A market. 28% of deals include a completion accounts mechanism and 23% of deals do not provide for price adjustment (such deals tend to have simultaneous signing and closing).
Locked box mechanisms fix the deal price at an agreed date based on a set of accounts, with sellers giving undertakings that value will not be extracted, or leak, from the target before completion. In contrast, completion accounts mechanisms calculate the final deal price after completion, by reference to accounts drawn up to the date of completion. Buyers are therefore able to test and adjust valuation by reference to a target’s actual financials.
Breaking the figures down by jurisdiction, an interesting picture emerges. The proportion of French and German deals that feature a locked box are now as high as 52% and 64%, respectively. In the UK, the prevalence of locked boxes has returned to just under half of deals, having fallen to as low as 36% of deals in last year’s survey.
Private equity firms, which are seeking to deploy record amounts of unspent capital and traditionally favour locked box accounts, may be playing a role in increasing the frequency of locked box mechanisms in European M&A. The presence of US buyers in the UK market likely played a role in the decreased popularity of locked boxes in 2018. As a result of the weakening of the pound, we saw an influx of US buyers after the Brexit vote period. Locked box mechanisms are significantly less common in the US, where the majority of deals use completion accounts. The number of carve-outs (for which completion accounts are usually preferable due to a lack of robust financial information) and divestments in the market likely also influenced the figures in 2018. In our view, 2020 may see buyout firms compete against US acquirers with a keen interest in sterling transactions and a preference for completion accounts.
Deal Teams Bring Risk Experience to Deal Conditions, but Scope for Change Is Limited
There is a growing trend towards heightened national scrutiny of transactions and new legal tools to intervene in deals in sectors that were formerly not considered “sensitive”. These factors have led to a renewed focus on supply chains, trade, as well as acquirer and investor jurisdictions. Further, antitrust regulators have been responding to the presence of new technologies in global economies, leading to calls for greater policing of deals in affected market sectors. Antitrust and increasingly, national security clearances are common conditions on many deals. Notably, however, the uncertainty that these common conditions can bring to a deal, in addition to heightened global uncertainty, is not having an impact on the prevalence of other forms of deal conditionality.
Material adverse change (MAC) clauses can refer to events that have a negative impact on the market generally or, more specifically, on the target company’s business. Our market study captures both types of MAC. These clauses remain relatively uncommon on European deals. Having gained ground with an increase from 15% to 18% of deals between 2016 to 2017, the frequency of material adverse change clauses in European deals has fallen back to 10%, and only 3% of deals with PE sellers. MACs are slightly more common in the UK (10%) than in Continental Europe (8%).
The position on MAC clauses in the US is different to that in Europe — the vast majority of US acquisitions include MACs. In Asia, a mix of US- and UK-style acquisition documentation is used, and the approach to MACs tends to follow the style of the SPA. Sectoral differences are also noticeable — MAC clauses feature fairly regularly in oil and gas transactions (circa 45%), especially those involving upstream deals in which myriad challenges such as regulatory, physical, environmental, and operational issues can deplete the value of a target to a buyer (such as termination of licences, damage to facilities, oil spills, and oil production shut-ins in the target company). Such MACs, once negotiated, are typically drafted quite tightly so as to address one or more identified potential events, rather than broadly seeking to capture any value impacting event.
Given the economic and political environment in which deals are done, stakeholders may be tempted to think that MAC clauses will become more prevalent in Europe. However, as long as competitive pressures remain on buyers, expending commercial goodwill in MAC negotiations will be challenging.