May 6, 2021

A New Approach to MACs

As we’ve seen repeatedly over the years, determining whether or not a “material adverse change” in a target’s business is not a straightforward process. However, there’s an interesting new article from Iowa Law prof Robert Miller that suggests a new approach to assessing whether a MAC has occurred that he argues “solves all the problems” in the existing MAC caselaw.  This excerpt summarizes Prof. Miller’s proposed approach:

Beginning from the foundational premise that a material adverse effect should be understood from the perspective of a reasonable acquirer, this article argues that such an effect is a material reduction in the value of the company as reasonably understood in accordance with accepted principles of corporate finance—that is, as a material reduction in the present value of all the company’s future cashflows. Hence, to determine if there has been a material adverse effect, the court has to value the company twice, once as of the date of signing and again as of the date of the alleged material adverse effect, in each case much as it would in an appraisal action.

Valuing the company is easier and more reliable in the MAE context than in the appraisal context, however, not only because the court need obtain only a range of values for the company at the two relevant times (and not pinpoint valuations as in appraisal proceedings) but also because it turns out that there is a canonical way to determine if a reduction in the value of the company would be material to a reasonable acquirer.

Of course, everybody’s first reaction to this is that the appraisal experience has shown that valuations – even ranges of valuations – can be pretty slippery concepts.  But the article argues that the dynamics of the negotiation process will help eliminate some of the problems inherent in appraisals:

[P]rior to signing the agreement, each party, along with its financial advisor, will almost certainly have valued the company using a discounted cashflow analysis. These analyses will have been produced not to generate extreme values for the purposes of litigation but to produce accurate values to assist the parties in negotiating the transaction.

Furthermore, given the widespread agreement among investment bankers regarding valuation methods, and given too that investment bankers on both sides tend to rely on management’s cashflow projections, in most cases these pre-signing discounted cashflow analyses are likely to produce similar valuation ranges.

Since both sides are likely to have a similar starting point in their valuation analysis, the article also argues that the process of determining whether there’s been a material reduction in anticipated future cash flows will also be more straightforward.

John Jenkins