Whilst press coverage of the credit crunch, recession and financial collapse goes on unabated it is important to realise that M&A deals are still being done, admittedly on a smaller scale and of a different variety – buying insolvent businesses rather than successful ones.
The volume of transactions has slowed due to lack of funding and the fact that buyers are undoubtedly waiting until they feel we are approaching the bottom of the market. Once that point is reached, we will see an increase in deal activity.
Those who are not prepared to commit to a purchase just yet on the basis that prices are still too high are using the time to arrange funding to allow them to take advantage of opportunities quickly when the time is right. This more difficult environment for doing deals is influencing the preferred structure and timetable of transactions.
In the boom times when high income multiples were being paid for cash generating businesses, the sale process was clearly biased in favour of the sellers, with auctions, limited warranties and locked box price structures all common place.
In today's climate with very restricted access to debt funding, a situation that is likely to continue for the near future, other funding methods need to be considered and alternative structures explored.
Many more deals now have deferred payments or earn outs as part of the consideration. Sellers have numerous concerns here.
Firstly sellers are concerned that on entering into negotiations buyers actually have funds readily available to make any up front cash payments and are frequently asking for comfort on this prior to entering into detailed negotiations.
Secondly, what is the security for any deferred cash payments? Ideally, sellers will want sums placed on deposit or a bank guarantee.
Thirdly if there is an earn out element based on future profits sellers are concerned about the current economic climate and that factors outwith the buyer's control may affect future performance. This is leading to detailed negotiation of how earn out payments will be calculated and what factors have to be taken into account.
Locked box deals allowed the seller total certainty as to the price being paid, (the price being calculated using a pre-agreed balance sheet and this pushed the risk of overpayment onto the buyer. With a tight funding environment, this is no longer acceptable to buyers and so we are seeing a move back to standard completion accounts with an adjustment to the price post completion based on accounts prepared to the completion date. A cap on any upwards adjustment is common in order to allow certainty on the buyer's funding requirements.
Gaps between signing and completion of a deal are never ideal and unless absolutely essential for regulatory reasons are becoming even less popular. The reason for this is primarily the risk of losing bank funding for the transaction. Banks often have Material Adverse Change (MAC) clauses in their facility agreements and are increasingly relying on these to pull deals.
In the past it was often the case that whilst a MAC clause would be contained in the banking documentation it would not be reflected in the sale and purchase deal as they were very seldom relied on by banks. That is now a high-risk strategy and whatever rights the bank have to walk away from their obligation to fund should be mirrored in the deal documentation.
One option to make a MAC clause more acceptable to a seller is to undertake to pay all their costs if indeed the buyer does walk away post signing, although this can bring its own funding difficulties.
Deals are more difficult to do in this new environment but opportunities will abound for those with funding available in 2010 and beyond, so it's not all M&A doom and gloom!
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