December 13, 2022

Private Equity: Deal Terms Tighten as Market Cools

According to this PitchBook article, the cooling M&A market has resulted in more extensive due diligence and, as this excerpt explains, a bit of a comeback for indemnity arrangements and meaningful escrows in PE deals:

Buyers have been taking more time to dig into a target’s financial standing and, in some cases, have been negotiating stronger indemnity provisions to protect themselves against downside risks facing the assets they are looking to buy, lawyers involved in private equity deals said.

In recent months, investors have been more often advocating for provisions to indemnify themselves from losses that could arise from specific liabilities discovered during the negotiation and due diligence process.

To backstop these indemnities, sellers sometimes set up a separate escrow to withhold proceeds from the sale for a set period of time. The funds in the escrow could amount to between 7.5% to 12.5% of the purchase price, according to Morley Fortier III, a partner at law firm Reed Smith. In the case when the seller is an operating business and has sufficient assets to cover the liability, the buyer may not require a separate escrow.

The article notes that in recent years, it has become very unusual for buyers participating in a competitive process to require an indemnity provision seeking recourse from a PE seller, according to Fortier. Buyers in those deals have typically been limited to recovery under the RWI policy. However, as the market cools, buyers are becoming more attuned to risk allocation during the negotiation process, and that is being reflected in the indemnity and escrow arrangements they’re negotiating.

John Jenkins