For a deal to cross the finish line, experienced M&A professionals rely on months of painstaking planning and due diligence. In deals involving private target companies, an important part of that due diligence is analyzing previous “peer” transactions, or closed transactions that fit a similar mold to the transaction on the table. For deal-term negotiations between buyers and sellers, deal parties and their counsel often start with peer transactions to draft provisions on everything from financial and indemnification terms to closing conditions and dispute resolution provisions.
During these negotiations, one of the issues that is usually debated is what deal terms are standard in the market. In these talks, deal parties often have to rely on surveys that aggregate terms from previously closed transactions. The limitation, however, is that much of this data is based on a limited range of deals that are not always reflective of the transaction at hand.
This is because data on private-target M&A can be difficult to find, unless the acquirer is publicly traded and has disclosed the deal terms to the Securities and Exchange Commission (SEC). Most of the transactions reported to the SEC are deals in which the deal size was large enough relative to the buyer’s size to render it “material” for SEC purposes. While such data is valuable, it excludes most transactions involving very large buyers purchasing smaller companies, which are normally not “material” from the SEC’s point of view. In other words, publicly available data on private-target M&A generally does not include many relevant transactions.
It is also important to recognize that M&A transactions involving privately held companies do not comprise a single, unitary market. Typically, a deal involving a very large buyer acquiring a small privately held company is very different from a deal involving a small buyer acquiring a large privately held company. Those deals should be viewed as belonging to different markets.
The Buyer Power Ratio
To help rectify these limitations, SRS Acquiom partnered with the M&A Committee of the American Bar Association’s Business Law Section (ABA Committee) to examine how changes in the ratio of buyer to deal size affected expected outcomes. Rick Climan, an experienced M&A attorney at Hogan Lovells and former chair of the ABA Committee, led the study and conceptualized what the study’s authors have termed the “Buyer Power Ratio.”
The BPR calculates the ratio of a public acquirer’s market capitalization, at the time of signing the acquisition agreement, to the purchase price of a privately held company. For example, an M&A transaction in which the size of the buyer is 20 times the purchase price for the target company would have a BPR of 20. This ratio is a good predictor of the deal parties’ relative leverage in deal term negotiations.
In what will not come as a surprise to experienced negotiators, the SRS-ABA Committee study shows that buyers generally get more favorable terms on certain key deal points as the Buyer Power Ratio increases. Conversely, sellers tend to get more favorable deal terms as it falls.
In conducting this study, we also used buyer and transaction size separately to filter the same data from some 400-plus transactions. But it was the BPR that was the best predictor of outcomes, while the results from the other filters were considerably more random. The authors believe that this is because BPR is the only filter that that considers the relationship of the parties’ respective sizes, as opposed to viewing them in isolation.
The Buyer Power Ratio, according to Climan, “is a powerful new tool for dealmakers. As more M&A practitioners get familiar with it, it’s bound to influence the way future deal negotiations play out. To the extent they find it useful to consult statistics on market practice, buyers and sellers should be utilizing metrics like BPR, in combination with sizable data samples, to help them zero in on the precedents that matter most.”
In addition to allowing for more focused negotiations between the lawyers, the BPR should also improve discussions between M&A attorneys and their clients. Many clients simply want to know that they’re getting a fair deal. If data from other studies leads them to believe that the deal terms offered are not standard in the market, it could potentially derail a transaction. By demonstrating to clients that they are in fact getting a “market” deal for the specific type of transaction they are engaged in, M&A attorneys can use the BPR to better set expectations.
During a competitive sale process, the study data can help sellers assess the terms they are likely to be offered by the various bidders, while buyers can use it to anticipate what other bidders are likely to offer. Large serial acquirers can determine whether their “standard” deal terms are comparable to what their peers are generally obtaining.
The BPR is not the only factor that can affect the respective parties’ negotiating leverage. Among other considerations that may come into play are the purchase price a buyer is willing to pay, the importance of the transaction to the buyer relative to its importance to the seller and the presence of competing bidders. The SRS-ABA Committee study did not attempt to measure the impact of these other factors on deal terms.
Market data is a valuable tool, but is far from perfect in determining what the expected or best possible outcome should be for any given transaction. Negotiations should be driven by reasoned analysis and logic. To the extent that an understanding of market data is helpful, however, the SRS-ABA Committee study and the application of the BPR allow for the most accurate information available.
Paul Koenig is an attorney, entrepreneur and co-founder of SRS Acquiom, a platform provider for managing M&A transaction payments, risks and claims.