Ana Calves
In 2021, we saw record levels of M&A activity, with global deal volume surpassing $5 trillion for the first time. While dealflow remains strong, with rising inflation, supply chain disruptions and the war in Ukraine, it is hard to predict whether this trend will continue. As middle-market deals move forward, the uncertainty posed by current market conditions will undoubtedly factor into acquisition offers.
Below are three key areas where sellers may start to see changes in a M&A letter of intent (LOI):
Lower Purchase Prices and Financing Conditions
Buyers, facing higher transaction costs and potentially smaller return on investment, may offer sellers lower purchase prices. Inflation increases the costs of operating a business, which may already be higher than normal due to supply chain issues. If the target company cannot pass cost increases to customers, or otherwise mitigate impact, the company’s profits (and in turn, the value of buyer’s investment) will decline. Additionally, inflation is expected to lead to increased interest rates, which means higher costs for buyers financing transactions. Therefore, sellers may see a so-called “financing out” in the LOI, which would make consummation of the deal contingent on buyer’s ability to obtain satisfactory financing.
Alternative Payments
Buyers may also propose alternative payment structures that require less cash to be paid to sellers at the time of closing. For example, a buyer may make a portion of the deal consideration contingent on the target company reaching certain financial milestones following the closing. These so-called “earnout payments” would be paid to the seller only if such milestones are reached. Similarly, a buyer may: (a) issue seller a promissory note, payable over several years, for a portion of the purchase price, (b) allow seller to retain a minority interest in the target company and/or (c) offer seller the opportunity to “rollover” a portion of its equity in the target company into buyer or one of its affiliates.
Longer Exclusivity Periods and More Extensive Diligence
Finally, middle-market buyers may request longer exclusivity periods to allow time to perform a more detailed due diligence review – and to the extent issues are uncovered, negotiate appropriate purchase price adjustments. For instance, contract diligence may be an area of particular focus in today’s inflationary economy. A buyer will want to understand the company’s pricing arrangements with its suppliers and the contracting parties’ ability to amend the terms of an agreement. For example, has the company locked in a most favored nation pricing provision or will a supplier’s pricing be based on market rates? Is the supply contract for a set term, or is it terminable at will by either party?
Given the prevalence of seller-friendly terms in the 2021 M&A market, buyers may see pushback from sellers in these areas. Both buyers and sellers should work closely with counsel to ensure they understand the terms of the LOI and potential implications. Counsel can also help both parties find an appropriate middle ground that ensures risks are allocated equitably.
