SRS Acquiom recently released its annual M&A Deal Terms Study for 2024 (available for download). This year, SRS Acquiom analyzed more than 2,100 private-target acquisitions that closed from 2018 through 2023. Here are some of the key findings summarized in the introduction:
– Strategic buyers (both U.S. public and private) were more active in 2023, with a corresponding substantial drop by U.S. private buyers backed by private equity (e.g., portcos).
– “GAAP consistent with the target’s past practices” is for the first time no longer the majority practice when establishing the accounting methodology for PPAs; the “worksheet” approach is now used on more than one third of deals. The median size of separate PPA escrows has now reached 1% of transaction value.
– One third of 2023 deals included an earnout, which is more than a 50% increase year over year (close to one fifth of deals in the previous three years included an earnout). The amount of contingent consideration tied to earnouts also ticked up slightly.
The study dedicates a slide to additional information on each of these points, plus valuation, deal structure, deal escrows, indemnification and RWI.
This survey by BCG and Gibson Dunn concludes that ESG due diligence has become “indispensable” for M&A. Two-thirds of survey respondents have engaged on ESG topics during transactions, and 75% reported that they identified a material ESG issue in a deal in the last three years because they conducted due diligence. Respondents generally felt that “the insights gained from these assessments are crucial not only for mitigating risks but also for preserving and enhancing deal value.”
When assessments uncover material ESG issues, dealmakers say that they usually negotiate financially and legally viable solutions that allow the transaction to proceed. These mechanisms include reducing the purchase price, refining the deal structure, and agreeing on specific indemnities, to name a few. Dealmakers also pointed to the tangible rewards of conducting ESG due diligence—such as protecting up to 10% of a deal’s value—that often surpass the associated costs.
There was significant variation in the data by deal size and region:
Europe is at the forefront, with ESG due diligence performed in half of the deals, compared with one-third of the deals in North and South America and Asia.
Buyers are more likely to include ESG considerations for large acquisitions, with due diligence occurring in approximately 60% of such deals. Buyers conduct ESG due diligence in approximately 40% of mid-cap acquisitions. For smaller acquisitions, the frequency of ESG due diligence falls to about 30%.
The survey revealed a similar pattern when respondents were asked how often they conduct ESG due diligence to prepare for selling a company.
But there was consistency in the use of outside advisors. 90% of the time ESG due diligence was conducted, outside advisors were engaged to assist.
Himawan v. Cephalon, Inc. (Del. Ch.; 4/24) presents a familiar fact pattern in life-sciences M&A. The target biotech company was developing one main asset for two possible indications. In its acquisition by Cephalon, its stockholders were entitled to “milestone” payments tied to regulatory approval of the asset for those indications. The merger agreement left the development of the asset in the buyer’s discretion, subject to its “commercially reasonable efforts” obligation (defined as “efforts and commitment of such resources by a company with substantially the same resources and expertise as [buyer], with due regard to the nature of efforts and cost required for the undertaking at stake”).
While the buyer paid the full milestone payment for one treatment, it ultimately abandoned drug development for the other indication. The target’s stockholders sued alleging that the abandonment constituted breach.
In 2019, Vice Chancellor Glasscock denied a motion to dismiss partially because plaintiffs identified similarly situated companies pursuing the abandoned treatment, but his perspective on this argument changed after trial. Here’s an excerpt from VC Glasscock’s post-trial opinion issued yesterday:
I note that in my decision rejecting the Defendants’ motion to dismiss in this matter, I suggested that one way to give meaning to the unusual language of the CRE Clause was to compare the efforts of similarly-situated pharmaceutical companies and their actions in the real world.
After trial, I find this method unworkable; no exemplar companies operate under the actual conditions of Defendants, who, I note, are also different from one another as to their circumstances. I find that the best interpretation of the contract is that the parties meant to impose the CRE requirement on the buyer, as it found itself situated, but that the requirement went beyond buyer’s subjective good faith. It imposed an objective standard—this is the meaning of the imposition of a requirement to “exercise . . . such efforts and commitment of such resources [as] a company with substantially the same resources and expertise as” the buyer.
He concludes that the defendants used commercially reasonable efforts despite abandoning one indication, stating that” ‘due regard’ for the ‘efforts and costs’ means that Defendants may eschew development where the circumstances reasonably indicate, as a business decision, that they not go forward.” He notes that assessing the costs includes the milestone payments and opportunity costs.
Plaintiffs point out that my reading of the CRE Clause gives sellers little protection, since it is invoked only to disallow actions of the buyer that would be against the buyer’s self-interest. But this reading gives the Plaintiffs all that the sellers bargained for.
Wachtell Lipton recently published the 2024 edition of its 237-page “Takeover Law and Practice” publication. It addresses recent developments in M&A activity, activism and antitrust, directors’ fiduciary duties in the M&A context, key aspects of the deal-making process, deal protections and methods to enhance deal certainty, takeover preparedness, responding to hostile offers, structural alternatives and cross-border deals. As always, the publication is full of both high-level analysis and real-world examples.
It has this to say about the recent market for acquisition financing:
Widely held concerns about inflation, rising interest rates and a possible recession combined to slow debt financing and deal activity in the first half of 2023. Borrowers deferred new debt deals, delayed planned refinancings and paused major corporate transactions while waiting for interest rates to top out. Financial sponsors, in particular, held back on debt-financed leveraged buyouts while watching to see whether interest rates (or business valuations) would fall. Direct lending remained hot, continuing to fill in market gaps, but it was by no means a borrower’s market, whether in terms of pricing, terms or leverage multiples.
The story changed somewhat in the second half of the year. Inflation slowed and deal activity picked up. […] When the dust settled, 2023 investment-grade bond issuance stood at $1.14 trillion, highyield bond issuance stood at $169 billion, and leveraged loan issuance stood at $737 billion. With the exception of the high-yield bond figure, which was up $65 billion from the 13-year low of
2022, those figures were basically flat year-to-year (and were paltry compared to the boom year of 2021, when high-yield bond issuance exceeded $450 billion and leveraged loan issuance exceeded $800 billion).
Sustained higher interest rates have also increased pressure on already challenged businesses that incurred (too much) debt in the days of “lower for longer.” […] Despite anticipated rate cuts in 2024, “higher for longer” remains the order of the day and markets seem to be embracing this new normal. 2024 is off to a dynamic start, but careful planning and sophisticated advice on debt-related issues will remain paramount, however the environment evolves.
The March-April Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This issue includes the following articles:
– Lessons From the Activision-Microsoft Merger – Delaware Chancery’s Moelis II Decision Provides Cautionary Tale for Boards and Activists – Sears and (the Limited Scope of) Controlling Stockholder Fiduciary Duties
– Delaware Chancery Reminds Us That Directors Generally May Not Share Confidential Information With Stockholders Who Nominated Them
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
A recent lawsuit involving a buyer’s attempt to terminate a deal based on a seller’s alleged non-compliance with the purchase agreement’s financing cooperation covenant raises the question of when a buyer should have the right to walk away from a deal on that basis. Here’s a description of the lawsuit from this article in Weil’s Private Equity Sponsor Sync newsletter:
In Omni Newco, LLC v. Forward Air Corporation, Forward Air entered into a definitive agreement to acquire Omni by way of merger for a combination of cash in the amount of $150 million and stock in Forward Air, the cash component of which would be financed using debt. In connection with Forward obtaining acquisition debt financing, Omni agreed to certain customary financing cooperation covenants, including providing reasonable access to Omni’s books and records, furnishing information, and using reasonable best efforts to cooperate with Forward’s financing efforts during the
interim period. While negotiating the merger agreement,
Omni sought, but did not succeed in obtaining, a provision that failure for it to comply with these obligations would only result in the closing condition regarding covenant performance not being satisfied if and to the extent that the buyer was not able to obtain its debt financing as a result of Omni’s breach. Essentially, Omni didn’t want its efforts to help the buyer obtain acquisition financing to be a potential reason Forward could refuse to close.
The parties resolved their differences on the eve of trial, but the article says that the dispute highlights the need to consider whether a financing cooperation covenant should give rise to a termination right based on covenant non-compliance only if the buyer’s financing is not obtained as a result. From a seller’s perspective, limiting the buyer’s right to walk away in this fashion enhances deal certainty, but the article cautions that a record of trying to include language addressing this directly & failing will create a potentially problematic “legislative history” in the event of litigation.
Section 546(e) of the Bankruptcy Code provides a safe harbor from constructive fraudulent transfer claims for transfers that are settlement payments or payments related to a securities contract, when those transfers are “made by or to (or for the benefit of) … financial institutions.” Most commonly, the safe harbor is asserted to provide protection against such claims to public shareholders who receive merger consideration payments through a financial institution that serves as the buyer’s paying agent, but the 7th Circuit’s recent decision in PETR v. BMO Harris Bank N.A., (7th Cir. 3/24), affirmed a district court’s ruling that the safe harbor extended to transactions involving private companies as well.
The case arose out of a target company’s repayment of bridge financing provided by BMO Harris in connection with the target’s acquisition by Sun Capital Partners VI, L.P. That repayment also relieved Sun Capital of certain guarantees that it made to the bridge lender. After the target filed bankruptcy, the trustee filed claims against BMO Harris and Sun Capital alleging that the repayment and elimination of the guarantees involved a constructive fraudulent conveyance not protected by the safe harbor.
A federal bankruptcy court ruled that the Section 546(e) safe harbor did not extend to securities transactions involving private companies. An Indiana federal district court overruled that decision, and the 7th Circuit affirmed the district court’s decision. This excerpt from King & Spalding’s memo on the case explains the Court’s reasoning:
The Seventh Circuit next determined that the plain text and definition of “securities contract” is broad and unambiguous as used in section 546(e), and the 546(e) safe harbor therefore applies to transfers made in connection with securities contracts for both publicly and privately held securities. The Courts of Appeals for the Third, Fifth, Sixth and Eighth Circuits have reached similar conclusions.
The Seventh Circuit agreed that the stock purchase agreement, which involved privately held securities, clearly fit within the definition of a securities contract. The bridge loan authorization agreement also fit within the definition as an extension of credit “for the clearance or settlement of securities transactions.” The court also found that because the guaranty was a credit enhancement for the bridge loan authorization agreement, it fit within the definition of a securities contract as a “credit enhancement related to any agreement or transaction referred to in [the definition.]” The court also noted that the three agreements were additionally covered by the catch-all language of the definition, which includes “any other agreement or transaction that is similar to an agreement or transaction referred to in [the definition].
The 7th Circuit also held that the 546(e) safe harbor preempts state law claims that seek to recover value transfers that the safe harbor is intended to protect, because a holding to the contrary would essentially render the safe harbor meaningless.
Yesterday, the FTC adopted a final rule banning most non-competes in a 3-2, party line vote. Like the proposed rule, the final version includes an exception for non-competes entered into in connection with the bona fide sale of a business. The carve-out is contained in Section 910.3(a) of the rule, and here’s the relevant language:
Bona fide sales of business. The requirements of this part 910 shall not apply to a non-compete clause that is entered into by a person pursuant to a bona fide sale of a business entity, of the person’s ownership interest in a business entity, or of all or substantially all of a business entity’s operating assets.
Originally, the carve-out would have applied only to non-competes with a “substantial owner, substantial member or substantial partner” of the business entity. In turn, the proposal would have defined these terms to include only “an owner, member, or partner holding at least a 25 percent ownership interest in a business entity.”
In a prior blog on the proposed rule, I observed that ownership requirement would have excluded a lot of folks that a buyer has a legitimate interest in seeking a non-compete from as part of the deal. A number of commenters who otherwise supported the proposal pointed that out to the FTC, and the agency ultimately eliminated that 25% owner limitation in the final rule, noting in the adopting release that:
The proposed requirement that an excepted non-compete bind only a “substantial” owner, member or partner of the business entity being sold was designed to allow those non-competes between the seller and the buyer of a business which are critical to effectively transfer goodwill while prohibiting those which are more likely to be exploitative and coercive due to an imbalance of bargaining power between the seller and the buyer.
However, commenters persuasively argued that the proposed 25% ownership threshold was too high because it failed to reflect the relatively low ownership interest held by many owners, members, and partners with significant goodwill in their business. The Commission declines to maintain the “substantial” interest requirement with a lower percentage threshold for the same reason.
The rule becomes effective 120 days after publication in the Federal Register, but stay tuned, because the dissenting commissioners questioned the FTC’s authority to adopt the rule and litigation challenging it is certain. We’ll be posting memos on the rule in our Antitrust Practice Area. If you’re interested in some of the broader implications of the FTC’s new rule, check out this morning’s blog from Meredith on CompensationStandards.com.
Despite a bit of a checkered reputation, non-SPAC reverse mergers are still a thing, and this excerpt from a recent WilmerHale memo (p. 14) says that there’s been an uptick in these deals and that, for some companies, they are an attractive alternative to an IPO:
The trend of declining public company valuations (including a surprising number of companies trading at values below their net cash), coupled with challenging conditions in the traditional IPO market, has led to a significant uptick in reverse mergers with publicly held life sciences companies since the beginning of 2022. These transactions have originated most frequently with pre-commercial life sciences companies that are listed on a major exchange and suffer a scientific setback or other disruption leading to a restructuring (or winding down) of operations—often while holding significant amounts of cash.
In these circumstances, the reverse merger transaction results in the public company effectively reinvesting its cash into the business of the private company, giving the public company’s legacy stockholders the opportunity to continue to hold stock in a new business while the formerly private company takes advantage of the public company’s existing cash and stock exchange listing.
The memo goes on to review considerations in establishing the exchange ratio in a reverse merger, the SEC filing and review process, as well as issues associated with a simultaneous “sign & close” structure & the SEC’s potential classification of the public company as a “shell company.”
The rise of RWI has been one of the biggest stories in private M&A over the past decade or so, but according to a recent SRS Acquiom study, RWI usage on private deals appears to be plateauing. The study says that post-closing issues may be a big reason that dealmakers have tempered their enthusiasm for RWI. This excerpt highlights some of the specific concerns for sellers in deals using RWI:
Indemnification escrows are seldom returned to the sellers on deals with an RWI claim.
— Buyers could be highly motivated to quickly burn through the RWI retention amount to unlock coverage under the policy.
— Nearly half of deals with RWI include a general indemnification escrow as security for the sellers’ portion of the RWI retention.
Sellers and the shareholder representative may not be privy to claims made under the RWI policy since buyers are often the named insured.
— Buyers may fully exhaust RWI coverage before sellers are even aware there has been a claim, at which point sellers may be on the hook again.
— RWI providers are not as familiar with the target’s operations and financials and may not be able to defend against a claim as well as the sellers and shareholder representative.
RWI can add varying levels of complexity.
— When making a large claim against the policy, buyers may employ full resources, which could dramatically outweigh the resources available to sellers to defend the much smaller indemnification escrow amount (or the risk of losing such escrow might not outweigh the cost to launch such a defense).
— Sellers may still be on the hook for indemnification claims excluded from RWI coverage or when RWI coverage is exhausted and may end up going out of pocket, especially if the deal had a smaller indemnification escrow.
It isn’t just sellers who have reason to think a little harder about using RWI in a deal. That’s because RWI’s evolution in recent years toward becoming a commodity product hasn’t been good news for buyers.