Finland: Nordic M&A – Risks Re-Divided

Article by Jan Örndahl and Jarno Tanhuanpää

Introduction

The global financial crisis has had a significant influence on the Nordic M&A market. In the first half of 2009, M&A activity with Nordic involvement totalled EUR 19.7 billion. That is 62 per cent lower than in the first half of 2008. At the same time, the lack of financing options and the valuation differential that exists between the buy and sell side parties has led to a rise in market uncertainty. The shift to a buyers' market has also triggered a number of changes in market practice and hence structures such as vendor notes, shareholder loans and earn-out -provisions are more and more common in the current Nordic M&A market.

Securing Funding and Financing

According to the market intelligence, it is currently very challenging to acquire financing for deals valued over EUR 100 million and the portion of equity capital required normally amounts to 50 per cent of the value of the overall financing package. Considering the above, a key issue in the current market environment is the ongoing liquidity shortage in acquisition finance. One solution for bridging financing gaps in transactions is a vendor note. With a vendor note, a part of the purchase price owed is converted into a loan and is paid to the seller only upon the respective maturity of the loan. A vendor note is typically unsecured, ranks junior compared to bank financing and has a relatively long maturity. Therefore, the seller assumes credit risk when granting a vendor note to the buyer but benefits customarily from a relatively high interest yield. A vendor note is a good example of the fact that sellers are forced to bear more risk in transactions in the current market environment and, granting a vendor note is nowadays in many cases a prerequisite for the completion of transactions.

A shareholder loan is another example of the seller's increased risk exposure and more proactive role in M&A transactions. In the current economic environment, it is not necessarily a given that the target company will be able to settle its debts as they fall due during the time between signing and closing. Therefore, the buyer may require that the seller furnish the target company with liquidity, e.g. in the form of shareholder loans. However, it is worth noting that in case the loan is repaid to the seller at closing, in many Nordic countries the seller risks having to return the amount of the loan should the target company go bankrupt after the transaction.

Termination of the Transaction

The global financial crisis has brought a renewed focus on conditions precedent and especially MAC clauses (Material Adverse Change), as a number of parties have sought to better define their obligations under the acquisition agreements in light of market uncertainties. The wording of MAC definitions is nowadays more frequently a result of tedious negotiations between the buyer and the seller than before. The buyer will try to formulate a MAC in the broadest possible terms, so that an exit option is available in most circumstances. On the other hand, the seller will try to restrict the wording of MAC to restrict any chance of the deal falling through.

Typically a MAC definition will exclude certain events, such as changes in laws and general economic conditions that do not have a disproportionate effect on the target compared to the peer group. A recent market practice indicates that the most recent transaction agreements have often included a number of new and often deal specific carve-outs, such as:

• commodity price fluctuations,
• increases in costs of obtaining capital,
• seller's failure to meet projections and
• acts of war and terrorism.

In the current uncertain economic environment it is more and more common to link a MAC clause with a reverse break-up fee, which entitles the buyer to walk away from the deal at any time before closing against payment of a penalty fee that typically amounts to between one to three percent of the total purchase price. Generally, this means the seller is more willing to accept a broad MAC clause, since the possible termination of the transaction will trigger the penalty fee payable by the buyer.

In addition to detailed MAC clauses, the buyers insist on a variety of conditions precedent to the closing of the transaction. In a volatile market it is very important to secure the components creating the business value of the target until the closing of the transaction. For example, it is in many cases vitally important that the key employees continue to work for the buyer until the closing of the transaction and beyond. In many cases, the buyers also insist on securing the key customers through conditions precedent. For example, it could be stipulated that, in case the target loses a certain percentage of its key customers between the signing and closing, the buyer is entitled to walk away from the deal.

Purchase Price Mechanisms

Purchase price mechanisms offer tools for risk management both before and after the closing of the transaction. Locked-box mechanisms have been very popular in bull markets, particularly in transactions involving private equity. In a locked-box mechanism, a consideration for the target is agreed at a certain point of time (e.g. at signing), with the risk of the target performance passing on to the buyer. In the current buyer-friendly market environment, the buyer frequently insists that the purchase price must be determined according to completion accounts, where the purchase price is agreed subject to later adjustment (e.g. net debt or working capital) based on target's financial performance between the signing and closing.

In the current uncertain economic environment, the valuation differential that exists between the buy and sell side might be considerable due to the weak predictability of the future performance of the target company. The parties may also be unwilling to link the purchase price to the historical performance of the target company and, thus, completion accounts have lately lost some ground. Earn-out provisions have now more frequently been used as a solution to the valuation problem. An earn-out is a mechanism by which the seller receives a part of the purchase price only in the event that certain pre-set goals are achieved. An earn-out can be linked to a number of business performance indicators or measures, but typically it is linked to EBIT. It is very important that the agreed measures can be verified according to clear criteria and that there is a mechanism for resolving disputes in the event that the seller and the buyer are unable to settle any disagreements that arise.

Conclusion and Outlook

The global financial crisis has had a significant influence on the Nordic M&A market. The crisis has brought changes to the bargaining power of buyers and sellers, and sellers have to be more proactive if they want to close the deal. Deal structuring is also a key issue in the current economic environment, and the importance of competition and tax issues in particular will grow in the future. The risk of a failed process is much greater than before, and sellers are more willing to negotiate on an exclusive basis, making auction processes rare in the Nordic M&A market.

Although the deal flow and debt-to-equity ratios in acquisitions are likely to remain subdued for a while, there are clear signs of recovery in the Nordic M&A market. The financial market is gradually recovering, and banks have stated that they are willing to finance good deals. Recent rallies in the stock markets around the world have also restored confidence. Also, the fact that private equity investors have a great deal of uninvested equity capital in their funds bolsters a more positive picture of future developments in the Nordic M&A market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.