By Kip Wallen, SRS Acquiom
Deal terms for private M&A deals with a private equity fund buyer can differ greatly from the broader M&A market. To get deals done in a volatile 2022, financial buyers diverged from some of the buyer-favorable trends observed across the general market.
In our 2023 SRS Acquiom M&A Deal Terms Study, which analyzes private-target deal terms across more than 2,100 transactions, we saw a notable shift in the way deals are negotiated. Breaking down that data to look at deals with a PE buyer, however, reveals nuances among buyer types. Since PE buyers often have a different approach for indemnification structures, conventional wisdom may assume that deal terms for transactions with representations and warranties insurance (RWI) track with deals executed for PE buyers. However, the data breakdown shows a more complicated landscape for PE buyers. In fact, fewer than two-thirds of private M&A deals in 2022 with a PE buyer included RWI. In this article, we look at various deal structures with comparison data.
While PE buyers are less likely to use equity as a form of deal consideration (14% of 2022 deals compared with 27% across all buyer types), 54% of PE buyer deals included a management-rollover component in 2022. Financial buyers often have the existing management team of the target stay on to run the target’s business post-closing on behalf of the buyer; a management equity rollover mechanism can incentivize the management team and align their interests with those of the buyer. About one in six of those deals also included an earnout, which can further motivate the management team – if properly structured.
Financial buyers are more likely to pay cash
PE buyers included an earnout structure on 18% of private M&A deals (excluding life sciences deals) in 2022, compared with 21% across all buyer types. These earnouts were also much smaller, equating to only 13% of the closing consideration amount compared with 31% across all buyer types. PE buyers are more likely to use financial metrics to evaluate earnout achievement with 60% of earnout deals in 2022 using a revenue metric and 44% using an earnings metric. Three in five earnout deals with a PE buyer have multiple milestones, which is similar across all buyer types.
Consistent purchase price adjustments
Every PE buyer deal in SRS Acquiom’s 2022 deal terms database included a PPA, sometimes referred to as a working capital adjustment. Nearly 90% of such deals included a separate escrow for the PPA, and while the presence of RWI has an impact here, even PE buyer deals without RWI used a PPA escrow 70% of the time. PE buyers like to use bespoke PPA language, including through a standalone provision on 96% of deals and opting for an exhibited worksheet or specified accounting methodology approach on three out of 10 deals.
Record year for walk-away wins
Financial buyers may often have to find ways to sweeten their bid for an acquisition target when competing against strategic and other buyers, including sometimes giving sellers a no-survival, or “walk-away,” indemnity structure. In the 2021 private M&A market, when valuations were high and competition among buyers was fierce, it was not surprising to see more than two out of five deals with PE buyers structured as walkaways for the sellers, or 45% of deals with RWI and 41% of deals without RWI. However, somewhat surprising in the 2022 market, with significantly lower deal volume and less competition among buyers, 64% of PE buyer deals with RWI and 45% of deals without RWI were structured as walkaways.
General indemnity escrow sizes hold steady
Across all 2022 private M&A deals, the median size of general indemnity escrows remained 10% of the transaction value for deals without RWI, and 0.5% for deals with RWI, which held true for deals with PE buyers. The indemnity escrow does not tell the entire story, however. Nearly one-third of deals with a PE buyer included a special escrow in addition to the indemnity escrow and/or PPA escrow. While the median amount of all escrows aggregated together on PE buyer deals in 2022 with an indemnification escrow held steady at 10%, the median amount of all escrows for deals with RWI was 4% of the transaction value, or eight times the size of the general indemnification escrow alone.
Favorable financial terms for some sellers
In the 2022 private M&A market that generally saw a number of buyer-favorable swings in deal-term trends (learn more in the 2023 SRS Acquiom M&A Deal Terms Study), financial buyers were able to close deals by working with sellers on certain financial terms such as fewer and smaller earnouts and more walkaway indemnity structures. While early indicators for the 2023 M&A market, burdened with continuing macroeconomic uncertainties, show ongoing lower deal volumes and valuations, movement in deal terms remains likely, as opportunistic PE buyers put their available dry powder to work.
Kip Wallen is senior director, thought leadership, at SRS Acquiom