Trends in M&A

After an absolute record year in 2021, the international M&A market had a varied 2022 with a strong first half of the year but significantly lower deal volumes in the second half of the year, especially in the higher end of the market. Certainly, the private equity segment has been facing a more difficult funding market in recent months, making acquisitions more expensive. This currently translates into less classic bidding processes where different buyers are played off against each other. We do see more and more complex transactions, including from companies that are struggling.

This year, DLA Piper again published its M&A survey based on more than 5,000 transactions that DLA Piper has overseen over the last decade (Global M&A Intelligence Report 2022 | DLA Piper).

Our survey again shows the difference in market practice between North America and Europe. For an open economy like Belgium with very active Belgian, European but also American acquirers, it is not unimportant to have a clear view of the basic differences between the various market practices. We list them briefly. In addition, we also highlight a trend that is becoming more and more prevalent in the Belgian acquisition practice, W&I Insurance.

1. Purchase Price Calculation

There are two common ways to lock in the purchase price in acquisition agreements.

First, there is the locked box method in which the purchase price for shares is calculated at a historical reference moment (e.g., the closing date of the last fiscal year). The advantage of this method is that buyer and seller already agree on an amount in the acquisition agreement. Buyer and seller then know at the signing of the acquisition agreement at what price the transaction will take place.

Alternatively, so-called closing accounts can be used, in which the price for the shares is calculated on the date of transfer of the shares (the closing date). In this case, the acquisition agreement contains a provisional price payable on the closing date. On closing date, the net financial debt (including cash position) and working capital are then typically recalculated. This method has the advantage of paying for the effective situation on the transfer date. The disadvantage, however, is that the buyer and seller must do the recalculation after the transfer date, which can lead to certain discussions after closing.

Locked box is very popular with private equity. We also see a lot of locked box deals in organized bidding processes. We see that in our European transactions, locked box was chosen in 52% of the cases. In North America, however, the picture is completely different. There, closing accounts are chosen in 98% of cases.

2. Conditions

Most acquisition agreements contain a number of conditions that must be met before the actual transfer of shares can take place.

Obtaining approval from the Belgian or European competition authorities is a common condition, especially in the larger transactions. In addition, more and more countries in Europe have recently introduced a regime for screening foreign investments (Multi-jurisdiction guide for screening foreign investments | DLA Piper). Belgium has also had a cooperation agreement on the introduction of an FDI screening mechanism since June 1, 2022. This mechanism would normally enter into force on January 1, 2022 but this has not happened so far. The introduction of this regime, will be an important new evolution in the Belgian acquisition market in 2023.

A final condition that is often debated is the so-called material adverse change clause (MAC clause) whereby a buyer can decide not to proceed with the transaction if an event has occurred that has a significant negative impact on the company being sold. A MAC clause can take many forms. The significant event may relate to the global economy, to the company or to a particular site.

In U.S. practice, a MAC clause is often provided (64% of cases). In Europe, a MAC is much less common (33% of cases). In addition to a classic MAC clause, American buyers also often request that the representations and warranties be confirmed both on signing and on closing of the transaction and this as a condition for closing the transaction, a so-called bring down of the representations and warranties. This is in se an extreme form of MAC.

3. Declarations and warranties, disclosure and maximum liability

As part of the sale of a company, a data room is basically created in which all important documents and financial data about the company are recorded. This enables the buyer to do the necessary due diligence. In addition, an acquisition agreement also contains a number of representations and warranties about the company being sold. If these representations and warranties are not accurate, this can lead to liability of the seller to the buyer.

The question that then arises is whether information contained in the data room qualifies the representations and warranties such that there is no liability of the seller if the information in the data room shows that certain representations and warranties are incorrect.

In a European context, dataroom disclosure is considered generally accepted (78% of cases). This is very different in the North American market where dataroom disclosure is only accepted in 22% of cases. In U.S. practice, so-called disclosure letters are often used that explain for each statement whether it is true or false. The chance of missing certain disclosures is obviously greater when working with a system of disclosure letter rather than data room disclosure.

The seller's maximum liability for breaches of representations and warranties also differs between U.S. and European practice. On most parameters the U.S. practice is rather buyer friendly but on this parameter we see a different trend. Often, the maximum liability for breach of representations and warranties in U.S. practice is limited to 10% where in European practice it fluctuates rather between 15 to even 40%.

4. S&I Insurance

A clear trend that we see in the acquisition practice in Belgium is the significant increase of the so-called W&I Insurance, the insurance against breach of representations and warranties.

The Belgian market has long lagged behind international market practice in this area (US but even Scandinavia and the Netherlands were much earlier in introducing this deal aspect).

Now W&I Insurance is common in the Belgian acquisition practice, even in the mid-market. However, it remains something for well-organized processes where the seller drafts the acquisition agreement and already immediately proposes a possible insurance.

In such cases, the seller's liability is often limited to a symbolic EUR and the buyer must therefore recover from the insurer. Important in this context is to also watch out for a so-called tipping basket. A tipping basket provides that when the deductible is exceeded, the insurer pays from the first EUR. If this is not provided for, there is a risk that the seller will still be liable for the amount under the deductible.

Internationally, we also see a trend toward specifically negotiated insurance policies for specific problems. However, experience in Belgium shows that W&I insurance is best part of a well-prepared process. Creative solutions are usually difficult to drag out in the last straight line to closing.