Trends in Private Company M&A

Transcription

1 Trends in Private Company M&A Stephen Salmon, Davis Polk Emily Roberts, Davis Polk Marcus Hintze, Coherent January 9, 2019 Davis Polk & Wardwell LLP

2 Introduction Still a seller s market: as a general matter the market for acquisitions of private targets remains extremely seller-friendly As a result, deal terms have continued their drift in favor of sellers Continued move of indemnification terms in seller friendly direction and increased number of no recourse public-style deals Increased use of MAE standard for bringdown of representations at closing Increasing adoption of limitations on extra-contractual fraud claims 1

3 Trends in Indemnification Consistent with the general trend, many key indemnification terms have become more sellerfriendly in recent years A recent survey found that the median general survival period for representations and warranties dropped to 15 months Deductibles and escrow sizes have also moved in seller-friendly direction Note though that some serial acquirors are still seeking and obtaining terms significantly better than the market medians including extended survival periods for IP representations, among others Increasing market acceptance of so-called double materiality scrape i.e. where uses of materiality qualifiers in representations are disregarded for purposes of both determining if a breach has occurred and the size of any damages These trends have been facilitated by the availability of representation and warranty insurance 2

4 Rise of the Public-Style Deal In many cases, buyers are agreeing to little or no post-closing recourse against sellers for breaches of representations and warranties, covenants, etc. (a.k.a. a public-style deal ) Ubiquitous in competitive auctions for PE-backed companies; corporates increasingly agreeing to these terms on the buyside and seeking similar terms on the sellside Increasingly, sponsors will also seek to cap their exposure on the purchase price adjustment to the amount of the corresponding escrow (consistent with the clean exit theme) At minimum, buyers should likewise seek to cap their exposure on the adjustment amount to the amount of the escrow, particularly since the sellers control the estimate process prior to close 3

5 How Are Buyers Responding? How are buyers trying to protect themselves? Increase the scope and depth of the due diligence exercise New areas of more in-depth focus (data privacy, compliance) Sellers generally seem to recognize trade-off between requiring buyers to accept limited post-closing remedies and providing broad access to information pre-signing (larger data rooms, answering specific follow-up questions, etc.) Preserving the ability to make fraud claims Get management on your side as early as possible so their knowledge can be leveraged against purchase price adjustment discussions and used to produce disclosure schedules as complete as possible Obtaining representation & warranty insurance 4

6 Representation & Warranty Insurance The trend of increasing use of R&WI in deals continues According to a recent study, approximately 29% of publicly available private deals referenced R&WI This includes deals involving corporate sellers in deals involving private equity sellers, in particular in competitive auctions, the use of R&WI is much higher Different levels of acceptance between private equity and corporate buyers, although corporate buyers are increasingly accepting the use of R&WI 25% 20% 15% 10% 5% 0% Buyer Seller Both 43% 23% 23% 8% Yes (for all reps, fundamental and general) Who Pays? 18% 45% Is the R&WI the sole source of recovery for rep breaches? 18% Yes (but only for general reps) 5

7 Representation & Warranty Insurance (cont.) Key terms: Deductible (the retention ) is typically 1% of target enterprise value Purchase agreement might also include a deductible; the delta (if any) can be covered by the seller (including through an escrow), which can reduce policy cost with seller skin in the game Policies typically include a retention step-down after the first months, Insurers will agree to a full materiality scrape for most reps, as long as the purchase agreement contains the same Premiums are typically 2-4% of the policy limit Survival period typically 2-3 years for general business reps and ~6 years for fundamental reps Can incept at signing by paying non-refundable deposit equal to 10% of the premium Inception at signing ensures coverage for pre-signing breaches that become known after signing, but before closing Key limitations: Policies will not cover: Known issues, including interim breaches (i.e., breaches that result from developments post-signing) This means no coverage for (i) breaches known by the buyer deal team prior to signing or (ii) issues first arising after signing that become known to the buyer deal team prior to closing Other sources of liability (e.g., breach of covenant, pre-closing taxes, appraisal claims) Other specific exclusions will be added as the insurer conducts due diligence (areas of known risk; areas where insufficient diligence conducted; areas where reps were added or indemnities sought to address specific concern) All matters are subject to retention, including breaches of fundamental reps Coverage may be modified (or unavailable) where the period between signing and closing is or could be longer than 120 days 6

8 Fraud Carve-Outs and Related Issues This is an evolving area in terms of contract drafting and negotiation. The key question is trying to define what is intended by fraud and the effect of the fraud exception. Whether claims for fraud against sellers outside the four corners of the contract are allowed Do claims for constructive fraud count? Is fraud exception limited to actual fraud (and exclude claims based on reckless or negligent fraud under equitable doctrines)? Can you make claims against innocent sellers? Sellers want the fraud exception to not allow for claims for joint and several liability (or even pro rata sharing) against sellers not involved in the fraud Privity of contract issues arising in sale by way of merger aggravates these issues In a merger, sellers provide that the target company is the entity making the representations 7

9 Trends in Sales to Sponsors Strategic buyers continue to have an advantage over sponsors not just in ability to bid more due to corporate synergies, but also in certain deal terms current market practice for mid-size to large assets is almost equivalent to (but not quite) an option to purchase the company at the reverse termination fee Reverse termination fee (usually 4-8% of the enterprise value) Payable if agreement terminated for breach of purchase agreement by buyer No debt financing closing condition: buyer assumes financing risk, to the extent of the reverse termination fee Serves as a cap on damages Limited specific performance If debt financing is available (and only if debt financing is available), and closing conditions are satisfied, seller has right to specifically enforce buyer s obligation to close (and to enforce buyer s obligations to fund under ECL) On the other hand, sponsor bidders generally do not have the regulatory/antitrust risk that may impact the certainty/timing of a strategic bidder 8

10 Allocation of Regulatory Risk Allocating risk and walk-away standard Regulatory undertaking defining efforts standard with precision v. so-called road map problem Reverse termination fee whether or not the RTF is exclusive remedy will depend on context Potential emergence of use of price adjustments in wake of Sherwin Williams/Valspar, etc. Ongoing risk of tit-for-tat regulatory rulings by MOFCOM and CFIUS and potential impact on global M&A 9

11 Material Adverse Effect New development: for the first time ever, the Delaware Court of Chancery finds than an MAE has occurred! Very high standard: an alleged MAE must substantially threaten the overall earnings potential of the target company in a durationally significant manner (i.e., measured in years, not months) and cannot be a short-term hiccup. The list of carveouts to the definition of Material Adverse Effect is long and seemingly grows longer every year Most significantly, any world-, country- or industry- wide effects are to be ignored for purposes of determining whether an MAE has occurred Akorn v. Fresenius Kabi: Delaware Chancery court finds (i) MAE and (ii) separate right to terminate based on target s failure to operate in the ordinary course of business MAE based on (i) unexpected entry of competitors and the loss of a key contract and (ii) breach of regulatory representations Ordinary course covenant breach based on failure to remediate deficiencies, continue an audit program, maintain data integrity systems and conduct a proper investigation into whistleblower allegations Notwithstanding that M&A lawyers can no longer claim that an MAE has never been found, case essentially reaffirms the long-standing guidance of Delaware courts that buyers will continue to bear an extremely heavy burden in establishing a stand-alone MAE to avoid their obligations to close 10

12 Biographies 11

13 Stephen Salmon PARTNER Steve Salmon is a partner in Davis Polk s Corporate Department, practicing in Northern California. He has extensive experience in both mergers and acquisitions transactions and a variety of capital markets offerings for clients across many industries. Steve has extensive experience in a range of capital markets transactions, including IPOs, follow-on equity offerings, convertible note offerings, and investment grade and high yield debt offerings. He advised the underwriters on the IPOs of Aimmune Therapeutics, Denali Therapeutics, Coherus BioSciences, Internet Brands, UCP, Virgin America, and Violin Memory. He also has an active M&A practice in both public and private transactions, including advising clients such as Agilent, Blue Coat Systems, Citigroup, Coherent, Dialog Semiconductor, D&M Holdings, Ingram Micro, J.P. Morgan, Mirion Technologies, Oracle, Reliance Steel, UCP and World Kitchen. RECOGNITION Northern California tel fax stephen.salmon@davispolk.com Mr. Salmon is recognized as a leader in the legal industry: Super Lawyers Rising Star, Daily Journal "Top 40 Under 40," 2016 PROFESSIONAL HISTORY Partner, 2015-present Associate, ADMISSIONS State of California EDUCATION B.A., Philosophy, Yale University, 2000 cum laude J.D., Stanford Law School,

14 Emily Roberts ASSOCIATE Ms. Emily Roberts is an associate in Davis Polk s Corporate Department, practicing in Northern California. She advises companies in a variety of industries on mergers and acquisitions, capital markets transactions and other general corporate matters. She has an active M&A practice in both public and private transactions, including advising clients such as Agilent, Blue Coat, FormFactor, Equinix, Ingram Micro, Reliance Steel, Roper Industries, Sunpower, Temasek and TerraVia. Emily also has extensive experience in a range of capital markets transactions, including IPOs, equity offerings, convertible note offerings, and debt offerings. She advised on the IPOs of Achaogen, atyr Pharma, Bloom Energy, Elastic, Kodiak Sciences, Revance Therapeutics and Yelp. Emily regularly advises on public reporting, securities compliance and corporate governance for companies such as Bloom Energy, Equinix, FormFactor, Ingram Micro, Oracle and SunPower. PROFESSIONAL HISTORY Davis Polk since 2011 Northern California tel fax emily.roberts@davispolk.com ADMISSIONS State of California EDUCATION B.A., American Studies, Stanford University, 2006 Phi Beta Kappa J.D., Stanford Law School, 2011 Gerald Gunther Prize in Corporations Thelton E. Henderson Prize in Community Law Clinic Articles Editor, Stanford Law Review 13

15 Marcus Hintze CORPORATE COUNSEL COHERENT INC. Mr. Marcus Hintze is Corporate Counsel at Coherent where he focuses on M&A, Securities and Compliance. Prior to joining Coherent, Marcus was an associate in the Northern California, Madrid and New York offices of Davis Polk & Wardwell where he advised U.S. and non U.S. companies in a variety of industries on capital markets transactions, mergers and acquisitions and other general corporate matters. Marcus received his JD from Brigham Young University and his BA in International Studies from the University of Utah. 14