More US buyers — and more buyer-friendly deal terms — are entering the seller-friendly UK market, although the picture is increasingly nuanced.
By Joshua M. Dubofsky, Sam Newhouse, Jennifer N. Cadet, and Catherine Campbell
Whilst global M&A deal volumes have dipped at the start of Q1 2023, UK-bound M&A activity is expected to be one of the year’s highlights as overseas buyers seek out attractively priced British public and private targets. Within this activity, the deal term preferences of US buyers are likely to impact private UK M&A. A detailed understanding of both UK and US expectations is therefore essential for transatlantic dealmakers.
US private M&A deal terms — particularly related to deal certainty and post-closing recourse — have historically been viewed as more buyer-friendly than those in the more seller-friendly UK market. However, the picture is increasingly nuanced, and deal teams navigating ongoing economic uncertainty and financial market dislocation are being called upon to find new solutions to deal valuation, certainty, and recourse concerns.
Valuation and Transfer of Risk
The US and UK markets have different approaches to valuation and the transfer of economic risk. Private European and UK deals commonly feature “locked box” mechanisms, which contrast with the completion account mechanisms used in most US deals. Completion account mechanisms generally provide the seller with the operational benefit of the business, including cash and account receivable generation, as well as the ongoing cost of funding the business and related operational risk, until closing.
In private deals, UK sellers should expect US acquirers to ask for completion accounts, and US buyers should be aware of a typical UK seller’s expectations. In order to advance its position, a UK seller focused on using a locked box structure should be ready to deliver audited financial statements to a US buyer or otherwise have accounts prepared that buyers can confidently rely on. If working on a tight timeline, US buyers can push for completion accounts on the basis that they do not need to do the upfront work of agreeing on locked box accounts and instead just need to agree on the methods that will be used to adjust the purchase price at closing.
The prevalence of locked box mechanisms may decrease further in the UK in 2023 if US acquirers favouring completion accounts outpace UK PE buyout firms, which are expected to continue a slower pace of transactions given debt markets constraints. Where locked box mechanics are used, ticking fees may become more prevalent, in particular as global complexity and timelines for M&A antitrust and regulatory processes continue to increase.
— Mechanism fixes the deal price at an agreed date based on a set of accounts and view the buyer as owning the financing requirements and results of operation of the business from that date
— Seller provides undertakings to the buyer that value will not be extracted or “leak” from the target before completion of the acquisition
— Value may be subject to a negotiated “ticking fee” to reflect cashflow generation within a mutually agreed pre-closing period
— Mechanisms include cash, debt, and working capital adjustments
— Calculate a final deal price after completion of the acquisition by referring to an estimate of target’s accounts at the date of completion
— Allows for post-closing valuation adjustments based on a final accounting adjustment mechanism
UK and US dealmakers take different approaches to closing conditions. In the UK or Europe, assuming satisfaction of any regulatory or antitrust conditions, deal and business risk is typically transferred to the buyer upon signing of a deal. Under US practice, deal and business risk is typically not transferred until deal completion. With increasing numbers of US acquirers in the UK market, UK dealmakers can expect to discuss a wider range of deal conditions than in the past and should familiarise themselves with the US approach to conditionality.
Common conditions which must be satisfied before a deal can complete
|UK / Europe||United States|
|Receipt of any required regulatory and antitrust approvals||X||X|
|Requirement for the seller’s representations and warranties to be materially accurate at completion||X|
|Material compliance with interim covenants||X|
|Absence of a material adverse change (MAC)||X|
MAC Clauses in Focus
Material adverse change (MAC) clauses, which give a buyer the right to walk away from a deal in the event of a MAC to the target business between signing and closing, are far less common in the UK than in the US.
Although MAC clauses are commonly included in US documentation, a MAC is seen as a truly significant and sustained adverse change in the target’s business that was not known to or anticipated by the buyer as of signing. As a result of this high threshold, US courts very rarely find that a MAC existed. Instead, US buyers will walk away from acquisitions following the target’s failure to satisfy a closing condition likely tied to a material breach of interim covenants or, where a materiality standard other than a MAC applies, a breach of warranties by the target.
As more US buyers enter the UK market, MAC clauses may become more common in UK deals. However, deal certainty remains critical, and UK sellers can be expected to resist requests for MAC clauses, particularly on competitive deals, instead relying on market precedent in Europe and the scarcity of case-law in the UK as to what may signify a MAC event (albeit this can be addressed with appropriate drafting). UK sellers that do agree to a more traditional US conditionality construct should focus on conditions related to compliance with covenants and accuracy of warranties.
Prevalence of MAC Clauses
Post-closing economic risk allocation in M&A in both the US and the UK is increasingly nuanced and requires a multifaceted approach to risk minimisation and mitigation.
Rising Appeal of “Public-Style” Deals
Historically, commercial warranties were a key tool in both US and UK private deals for understanding and allocating risk as well as forming part of the diligence and disclosure process. Today, the allocation of risk between buyers and sellers for commercial warranties and other common areas of recourse is changing. In the US, “public-style” or “no-recourse” deals have become much more common in the highly competitive M&A markets of recent years, providing private sellers with risk protection levels similar to those in public deals. In a no-recourse deal, buyers have no recourse against sellers after closing for any breaches of representations, warranties, and pre-closing covenants.
In the UK, buyers’ ability to seek recourse post-closing has also narrowed, though this trend remains deal dependent. Competitive deals have seen buyers accept a limited or sometimes nominal level of seller recourse by way of warranty protections. Regardless, parties generally make exceptions to carve out obligations that are to be performed following closing and for claims for fraud.
|United Kingdom: A breach of warranty claim typically requires a buyer to prove how the breach reduced the overall value of the acquired shares, so these purchase agreements require buyers to rely more heavily on specific indemnities, and, in recent years, insurance.
United States: Traditionally provided buyers with strong recourse against sellers through claims for breaches of representations and warranties, often given on an indemnity basis, in addition to escrow or holdback arrangement.
Warranty and Indemnity Insurance
If a seller is not willing to stand behind warranties, then warranty and indemnity insurance (W&I) (or representations and warranty insurance (RWI) in the US) can provide a solution, with the insurance market offering a range of M&A risk management options for acquirers.
Insurance has become an important component of UK transactions in recent years. However, many buyers are now more critically evaluating the merits of W&I due to changing market dynamics and challenging macro conditions (which have cooled deal flow). As W&I has matured and buyers have become more experienced consumers of the insurance (and of low or nominal liability caps for warranties), the emerging picture is one of a product with a nuanced value. Deal-specific characteristics, structures, and issues are playing a key role in the demand for and success of W&I.
Increasingly, buyers in the UK are opting to forgo W&I altogether — instead accepting that they will have no recourse against the sellers and choosing to spend the W&I premium costs elsewhere. They are relying on the disclosure process, taking comfort from management roll-over/seller reinvestment, and assessing/pricing any issues as they come to light. Despite the current slowdown, W&I will likely remain a feature of UK dealmaking in the coming years. However, W&I is not a panacea for all transactions, and dealmakers should structure processes accordingly.
In the US, use of RWI has increased significantly in recent years. In most transactions, PE buyers have migrated to a “no recourse” structure backstopped by RWI. Some US strategic acquirers have similarly moved towards a “no recourse” or “limited recourse” structure that generally permits claims for breaches of “fundamental representations” and/or for some portion of the deductible under an RWI policy. As with their PE counterparts, these buyers retain RWI, particularly in competitive auctions with PE sellers, as a backstop. However, many US strategic acquirers remain more focused on traditional US remedies, including seller indemnification and escrow obligations. The buyer requirements for a traditional remedy structure are often framed as part of the buyer’s willingness to pay a significant premium and the seller’s need to retain perceived post-closing accountability.
Given ongoing market uncertainty, deal practitioners expect UK and US market practice to pull back from the recent heavy focus on no-recourse transactions. US acquirers will likely expect a more traditional US approach, particularly in strategic acquisitions and proprietary PE transactions, and parties are likely to land on a hybrid recourse package.
The next 12 months will likely present significant opportunities for UK and US dealmakers, but in a world increasingly difficult to predict, dealmakers will need expert legal counsel to translate transatlantic terminology and guide optimal M&A terms to navigate key risks.
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