M&A Best Practices Whitepaper Series Earn-Outs / Contingent Payments

Transcription

1 Earn-Outs / Cntingent Payments The Delancey Street Partners M&A Best Practices Whitepaper Series prvides insight int key tpics that are highly relevant in tday s M&A market. Frm real-time market trends t exit planning initiatives, we explre ideas and cncepts that can have a material impact n value and likelihd f a successful utcme in tday s dynamic M&A envirnment. This installment f ur M&A Best Practices Whitepaper Series fcuses n cntingent payments, mre cmmnly referred t as earn-uts. Overview As readers may already be aware, an earn-ut is an M&A structuring mechanism in which a prtin f the purchase price is cntingent upn future perfrmance f an acquired business, typically ver a specified perid f time. Histrically, earn-uts were emplyed t bridge valuatin expectatins between buyer and seller. In additin, earn-uts have been cmmn in certain industries (e.g. bipharmaceuticals and medical devices) where the value f an acquisitin is heavily dependent n binary events such as the apprval f prducts. While the underlying ecnmic principals can be relatively straightfrward, hw best t measure and gvern an earn-ut t align interests between buyer and seller can ften be challenging t implement. As a result, the inclusin f an earn-ut can cmplicate r lengthen the transactin negtiatin prcess, with the suggestin f an earn-ut eliciting negative reactins frm bth buyers and sellers. Fr these reasns, ver the curse f ur advisry careers, we have rarely utilized earn-uts. When we did, they were designed t address seller-specific challenges. In recent years we have seen an increasing number f prpsals frm buyers that have included an earn-ut and have clsed transactins with earn-uts. In these cases, the earn-uts were sweeteners ffered by aggressive buyers lking t differentiate themselves. As the M&A markets have becme mre cmpetitive during the current cycle, buyers are turning t earn-uts as a tl t deliver additinal value abve an already full multiple at clse, ften in rder t entice a high-quality target business t sell early ahead f expected grwth. Delancey Street has advised n several transactins where substantial earn-uts were emplyed by buyers ver and abve attractive cnsideratin at clsing t pre-empt an eventual brader prcess. Such earn-uts are nt nly mre frequent but represent significant additinal value. Data frm the brader market (frm SRS Acquim) eches ur firm s experience: excluding life sciences transactins, f transactins in 2016 included an earnut and earn-uts accunted fr 33% f verall transactin value n average in 2016, up frm 25% in Trends in Earn-Out Prevalence and Size 20% 40% 18% 33% 34% 16% 28% 25% 22% 12% 16% 12% 10% 10% Number f Transactins with Earn-Out Earn-Out as % f Transactin Value Abut Delancey Street Partners Surce: SRS Acquim Delancey Street Partners is an independent, industry-fcused investment bank. We serve CEOs, Entrepreneurs, Sharehlders and Bards f Directrs f high grwth and middle market private and public cmpanies. Our services include strategic advisry, capital raising and independent bard advice. We advise n sell-side and buy-side M&A, grwth capital financings and recapitalizatins. Our fcus sectrs include Business Services & Technlgy, Healthcare, Industrial & Industrial Technlgy, and Infrastructure. Learn mre at: Page 1

2 Earn-Outs / Cntingent Payments Measuring Perfrmance ( Earning the Earn-Out ) Typically, the value f an earn-ut is based n the achievement f sme type f financial metric, such as revenue r EBITDA, ver a specified perid f time. The ecnmics f an earn-ut can als be based upn achieving nn-financial targets, such as prduct milestnes. Sme earn-uts emply a cmbinatin f financial and nn-financial metrics. When structuring the ecnmics f a ptential earn-ut, sme key cnsideratins include: Chsing the apprpriate metric: Fr earn-uts tied t a financial metric, sellers ften prefer t use revenue as it is least affected by any peratinal changes made by the buyer. In cntrast, buyers prefer t use EBITDA r a similar prfitability metric that is mre reflective f the cntributin f the acquired business. Cmplexity: Typically, earn-uts are structured as a percentage r multiple f revenue r EBITDA, r as a payment fr reaching a specific milestne. Hwever, ther mre cmplex features can be incrprated, such as minimum threshlds, caps n maximum payuts, tiered payment structures, etc. The mre cmplex an earn-ut, the mre difficult it is t dcument and gvern pst-clse. In these instances, revisiting an acceptable purchase price at clse may be a better alternative. Duratin: Based n data frm SRS Acquim, the majrity f earn-uts (72%) reslve within three years f clse with nearly 50% cncluding within tw years. An verly lng earn-ut perid can interfere with the successful integratin f an acquisitin. Earn-Out Calculatin Metric Prevalence f Cmplex Payut Features Earn-Out Length 100% 73% 70% 36% 29% 64% 50% 23% 30% 24% 34% Revenue EBITDA Other Surce: SRS Acquim 0% Cap Threshld Multiple Tiers Surce: Duff & Phelps 1 year r less >1 t 2 years >2 t 3 years >3 years Surce: SRS Acquim Page 2

3 Earn-Outs / Cntingent Payments Gverning the Earn-Out ( Rules f the Rad ) A key challenge f earn-uts is balancing the desire f the buyer t fully integrate the acquired business with the seller s gal t maximize the value f the earn-ut. In many instances, the seller retains n cntrl f the acquired business, and is wary f the buyer implementing peratinal changes that may adversely impact the revenue generatin r expense structure f the target. Cnversely, the buyer s gal is t maximize the lng-term value f the target as part f its platfrm, regardless f ptential shrtterm impacts t metrics that determine the earn-ut. As a result, there are number f cnsideratins which are typical negtiatin pints in transactins cntaining earn-uts. Prcedure fr determining earn-ut financial metrics: Typically the buyer and the seller will agree n a set f accunting principles t be applied during the earn-ut perid as a supplement t the usual financial statements, strictly fr purpses f measuring the earn-ut (i.e., prcedures fr determinatin f earn-ut EBITDA). Operatins f the business: There are a number f seller-friendly cvenants that are smetimes cntemplated when structuring earn-uts that have been n the rise in recent years: (i) cvenant fr buyer t cntinue perating the business cnsistent with past practices, and (ii) cvenant fr buyer t perate the business in rder t maximize the earn-ut. Cnversely, buyers (especially thse that are public) may limit their bligatins t the seller by explicitly disclaiming any fiduciary bligatin t the seller with respect t the earn-ut. Fr example, buyers may attempt t negtiate the fllwing r similar language: Seller agrees and acknwledges that the Buyer may frm time t time make business decisins in a manner cnsistent with the best interests f the cnslidated business peratins f the Buyer and its subsidiaries, taken as a whle, including actins that may have an impact n the Earn-Out. Except as therwise prvided in this Agreement, the Seller shall have n right t claim any lst earn-ut r ther damages as a result f such decisins s lng as the Buyer did nt intentinally take such actins fr the primary purpse f the payment f the Earn-Out Fr the avidance f dubt, Seller acknwledges and agrees that Buyer shall retain full and sle discretin as t the cnduct and peratin f the business f the Cmpany, and in n event shall Buyer have any bligatin (express r implied) t achieve r maximize the Earn-Out. Withut limiting the generality f the freging, Buyer may make frm time t time such business decisins and take such actins as it deems apprpriate in gd faith fllwing the Clsing, including decisins r actins that may have a negative impact n the Earn-Out. Acceleratin f the earn-ut upn a change f cntrl event fr the buyer during the earn-ut perid. Prevalence f Selected Earn-Out Features Nt Included - 84% Nt Included - 80% Nt Included - 92% Nt Included - 80% Surce: SRS Acquim Included - 16% Included - 20% Cvenant t Run Business in Accrdance with Seller's Past Practices Cvenant t Run Business t Maximize Earn-Out Payments Included - 8% Disclaimer f Fiduciary Relatinship Included - 20% Earn-Out Accelerates n Change f Cntrl Regardless f any prvisins and cvenants the seller may be able t btain, ultimately cntrl f the business is being relinquished t the buyer. As a result, the value ascribed t an earn-ut is greatly influenced by the level f trust between buyer and seller. Thus, while the verall cultivatin f trust thrughut is imprtant in any M&A prcess, it becmes even mre crucial in transactins that invlve earn-uts. Page 3

4 Earn-Outs / Cntingent Payments Case Study: Acquisitin f Symphny Healthcare by PRA Health Sciences On August 7, 2017 PRA Health Sciences annunced the acquisitin f Symphny Healthcare, which subsequently clsed n September 6 $530 millin cash cnsideratin at clse representing ~14x LTM EBITDA Additinal earn-ut pprtunity (referred t as Cntingent Cnsideratin in public filings) structured as fllws: 2017 earn-ut ptential equal t difference between $530 millin and 14x actual full year 2017 EBITDA 2018 earn-ut ptential equal t 25% f realized 2017 earn-ut plus an additinal $50 millin At clse, a ttal f $541 millin was paid t Symphny, inclusive f $530 millin f cash purchase price and apprximately $11 millin f earn-ut Althugh the maximum earn-ut ptential is uncapped, PRAHS recrded a fair value f $109 millin in cntingent liability at transactin clse Implied ttal enterprise value f $650 millin Cmpnents f Cnsideratin 18% TEV: $650M 82% Cnsideratin at Clse Earn-Out Surce: PRAHS Q Q Selected earn-ut gvernance prvisins: Cvenant t run business in accrdance with past practices (language frm PRAHS August 7, K) Parent shall use cmmercially reasnable best effrts t assist the Surviving Crpratin in achieving the aggregate Cntingent Cnsideratin and shall nt knwingly take (r knwingly cause any f its cntrlled Affiliates t take) any actin fr the primary purpse f preventing the achievement f the aggregate Cntingent Cnsideratin and shall use cmmercially reasnable best effrts t perate the business in the rdinary curse until December 31, 2017 Disclaimer f fiduciary duty t seller (language frm PRAHS August 7, K) (i) Parent and its Affiliates will be entitled t effect the integratin f the Surviving Crpratin and its Subsidiary and their business, assets and persnnel with Parent and its Affiliates, (ii) Parent and its Affiliates shall have the right t direct the verall peratins and strategy f the business f the Surviving Crpratin and its Subsidiary and may make all management decisins with respect t the Surviving Crpratin and its Subsidiary and their business (including all decisins with respect t the research, develpment, marketing and sale f its prducts and services), (iii) the Cntingent Cnsideratin (including whether and the extent t which sme r all f it may be achieved) is speculative, and there is n assurance that the Sellers will receive any Cntingent Cnsideratin, (iv) neither Parent nr any f its Affiliates we a fiduciary duty r express [ ] r implied duty t the Sellers, the Sellers Representative r any ther Persn in respect f the Cntingent Cnsideratin (and any such duty that may exist is hereby knwingly, vluntarily and irrevcably waived) Final Thughts Earn-uts are ptentially useful cnstructs t help bridge a gap in valuatin between buyers and sellers, facilitating a transactin that may nt be pssible thrugh purchase price at clse alne. In the past, earn-uts have been viewed warily by sellers as attempts by buyers t inflate a belw-market ffer with funny mney. In the current envirnment, buyers are increasingly turning t earn-uts as a way f delivering an abve-market value at clse r t give sellers credit fr significant future grwth that is anticipated pst-clse. Page 4

5 Earn-Outs / Cntingent Payments Infrmatin n Delancey Street Partners B. Andrew Schmucker Managing Partner aschmucker@delanceyllc.cm David K. Allebach Directr dallebach@delanceyllc.cm Senir Leadership Patrick E. Dlan Managing Directr pdlan@delanceyllc.cm Jacques H. Fu Vice President jfu@delanceyllc.cm William J. Filip Managing Directr wfilip@delanceyllc.cm Recent Transactin Experience Five Twer Bridge, Suite Barr Harbr Drive West Cnshhcken, PA Securities ffered thrugh SSG Capital Advisrs, LLC Member SIPC Member FINRA All ther transactins effectuated thrugh Delancey Street Partners, LLC The infrmatin and views cntained in this reprt were prepared by Delancey Street Partners, LLC ( DSP ). It is nt a research reprt, as such term is defined by applicable law and regulatins, and is prvided fr infrmatinal purpses nly. It is nt t be cnstrued as an ffer t buy r sell r a slicitatin f an ffer t buy r sell any financial instruments r t participate in any particular trading strategy. DSP makes n representatin as t the accuracy r cmpleteness f the infrmatin presented in this reprt. DSP may be a market maker r specialist in, act as adviser r lender t, have psitins in and effect transactins in securities f cmpanies mentined herein and als may prvide, may have prvided, r may seek t prvide investment banking services fr thse cmpanies. In additin, DSP r its respective fficers, directrs and emplyees may hld lng r shrt psitins in the securities, ptins theren r ther related financial prducts f cmpanies discussed herein. Opinins, estimates and prjectins in this reprt cnstitute DSP s judgment and are subject t change withut ntice. The financial instruments discussed in this reprt may nt be suitable fr all investrs, and investrs must make their wn investment decisins using their wn independent advisrs as they believe necessary and based upn their specific financial situatins and investment bjectives. Als, past perfrmance is nt necessarily indicative f future results. N part f this material may be cpied r duplicated in any frm r by any means, r redistributed, withut DSP s prir written cnsent. Page 5