Houlihan Lokey (HL) recently published its annual Purchase Agreement Study for the 2014 calendar year (the Study). The Study is focused on middle-market change-of-control transactions in which HL served as the financial advisor to either the buyer or the seller, and undertakes a review select terms of the purchase agreements for such transactions. The scope of the Study is broad, covering both public and private deals which vary by industry, size, and purchase price (ranging from $10 million to more than $1 billion).
The results of the Study are valuable. By assessing the terms of purchase agreements – with a particular focus on the indemnification provisions and how such provisions relate to the agreements' representations, warranties, and covenants – the Study offer valuable information and benchmarks within the middle market, and points to recent market trends as against the data set out in previous iterations of the study.
77% of all transactions in the last decade had representations and warranties that survived the closing of the deal. Within that group of transactions, the vast majority of the purchase agreements analyzed contained a claims basket, indemnity cap and/or an escrow. While there is no consensus on what constitutes "fair and normal" or "market" for any of these indemnification provisions (each term would be highly negotiated and dependent on the facts of the particular transaction), the results of HL's Purchase Agreements Studies over the past 10 years point to certain trends and patterns.
Below is a chart which sets out the mean, median and maximum values of the corresponding indemnification terms of the surveyed transactions over the past decade. In all cases, the magnitude of the numerical values is measured as a percentage of the purchase price.
The Study canvassed the purchase agreements with a view to identifying how many agreements contained aggregate claims basket, which provide that a seller is not required to indemnify for losses until the aggregate amount of all such losses exceeds a specified amount (the "basket"). There are two main types of baskets: (1) a dollar-one or "tipping" basket (i.e., when, once the aggregate amount of losses exceeds the basket, the seller is responsible for the aggregate amount of all losses) and (2) a deductible basket (i.e., when, once the aggregate amount of losses exceeds the basket, the seller is only responsible for losses in excess of the basket).
- Of the transactions in which the reps and warranties survived the closing, 84% had a form of basket in 2014 (as opposed to 88% over the past 10 years).
- Deductible baskets accounted for 76% of the baskets in 2014 (as opposed to 78% over the past 10 years)
- Dollar-one baskets accounted for the remaining 24% of the baskets in 2014 (as opposed to 22% over the past 10 years)
The Study also considered the purchase agreements in order to identify how many agreements contained a cap on the amount of damages the buyer could recover from the seller under the indemnification provisions.
- Of the transactions in which the reps and warranties survived the closing, 84% had cap on damages in 2014 (as opposed to 88% over the past 10 years).
- The median cap (as a % of purchase price) in 2014 was 9.8% (as opposed to 10.0% over the past 10 years)
- The mean cap (as a % of purchase price) in 2014 was 17.6% (as opposed to 13.8% over the past 10 years)
The Study also considered the purchase agreements with a view to identifying the frequency with which purchase consideration (consisting of money, securities, or other property or instruments) is withheld from the seller and deposited into an account at closing to provide protection to the buyer for the future payment of indemnification claims.
- Of the transactions in which the reps and warranties survived the closing, 77% had an escrow in 2014 (as opposed to 82% over the past 10 years).
- The median escrow (as a % of purchase price) in 2014 was 5.0% (as opposed to 7.0% over the past 10 years)
- The mean cap (as a % of purchase price) in 2014 was 6.0% (as opposed to 7.5% over the past 10 years)
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