Buyers dictate M&A deal terms

Given the turmoil in financial markets and the unwillingness of banks to
provide credit, companies with deep pockets that want to snap up smaller rivals
are in a much more powerful position to dictate deal terms than they have been
in recent years.

A survey by law firm CMS Cameron McKenna found that there has been a shift
towards more buyer-friendly contract provisions and that this trend is likely to
become more pronounced as buyers demand even better acquisition terms. However,
the survey also highlights a number of important differences in approach between
the US, UK and Europe.

Karma Samdup, a senior associate in the firm’s corporate department and
co-author of the survey, says, “If companies have the money ready to fund M
&A deals, they can leverage better contract terms. However, companies based
in different countries opt for different methods to increase their security when
negotiating deals because of a combination of cultural, regulatory and
legislative considerations.”

According to the survey, buyers are negotiating better terms through the
following methods:
1. Cap on warranty claims
Buyers often seek to exclude certain key areas of concern from the overall
liability cap for warranty claims. Not surprisingly, in a buyer’s market,
liability caps on warranty claims have been increasing. However, the cap was
still less than 50% of the purchase price in around half the deals done in
2007-08 and in about one-third of deals it was 25% or less. In most cases, the
cap applied to all warranties, but buyers managed to carve out title and tax
warranties in about one-third and one-fifth of the time respectively across
Europe. In the UK, the aggregate cap was set at the purchase price in just over
40% of deals compared with 20% of the deals across Europe.

2. Time limit for warranty claims
In the UK, two-thirds of deals had a general time limit for warranty claims of
18 months or less, but elsewhere in Europe, the opposite was true with most
deals containing a time limit of 18 months or more, and more than 24 months in
Spain and Italy. There was also evidence that buyers across the region were
managing to negotiate slightly longer limitation periods ­ 31% of deals in the
second half of 2008 compared to 19% in the second half of 2007 contained time
limits for warranty claims exceeding 24 months.

3. Earn-outs
The use of earn-out mechanisms, where the purchase price is dependent on the
future performance of the target business, was relatively even in the UK and
Europe, with 14% of deals in the UK containing such provisions compared with 12%
across Europe (19% in the US). However, in the current market, earn-outs are
becoming more popular. Of all deals with a purchase price adjustment mechanism,
deals containing earn-outs as the basis for price adjustment increased from 9%
in the first half of 2008 to 15% in the second half of 2008.

4. MAC clauses
Material adverse change (MAC) clauses give the parties ­ usually the buyer ­ the
right to rescind the transaction if a material “negative event” provided for in
the agreement occurs before closing. Such an event could include the loss of a
major customer, or an investigation carried out by a regulatory or prosecuting
authority, such as the Financial Services Authority or Serious Fraud Office in
the UK. However, only 17% of European deals had a MAC clause, compared to 67% of
deals in Canada and 78% of deals in the US. MAC clauses were still relatively
rare in the UK. However, says Samdup, “MAC clauses are likely to be sought more
often in future as buyers try to get the best deal and protection possible.”

5. Price adjustment mechanisms
In the UK, two-thirds of deals included a completion accounts or other similar
price adjustment mechanism, usually based on levels of debt, cash, net assets or
working capital or a combination of these. One explanation is that English law
does not provide a clear and quantifiable measure of damages for breach of
warranty, so the parties must negotiate an operative provision to avoid
uncertainty. In Europe, deals included such price adjustment mechanisms only
about half the time, companies preferring instead the “locked box mechanism”
which provides for a fixed purchase price at signing.

6. Time when warranties were given
In the vast majority of UK deals, warranties were given at exchange, but only
rarely were they repeated or “brought down” to completion. In at least one-third
of deals in Italy, Spain, the Benelux countries, central and eastern Europe,
warranties were given at exchange and repeated at completion, though with no
further right to qualify them by disclosing matters that had arisen between
exchange and completion. In the US, warranties are brought down to completion in
nearly all cases.

7. Conditions to completion
In nearly 60% of UK deals, there were no conditions and exchange and completion
occurred simultaneously. However, the majority of continental deals included
conditions such as competition clearance (26%), regulatory approval (15%),
shareholder approval (14%) and securing finance by the buyer (13%). “France and
Germany have strong worker representative groups and their influence can make or
break a deal,” says Samdup. “In the UK, there are often fewer parties involved
so the whole process can take less time and there is little need or desire to
have conditions to completion.”

Useful links
To see CMS Cameron McKenna’s 2009 European M&A survey, contact the authors
at [email protected] or [email protected]