Cross-Border Middle Market Deals - In-Line With Current M&A Trends


Corporate & Finance Alert

July 7, 2009

In December of last year we published a summary of what we saw were the likely middle market M&A trends resulting from the continuation of the worldwide economic downturn.  Essentially we noted that negotiating leverage had shifted considerably from sellers to buyers and from borrowers to lenders. More specifically we listed the following as being the major trends we expected to encounter in the middle market M&A in 2009:

    • Greater percentage of purchase price consideration paid in cash/stock of buyer rather than from proceeds of debt financing.
    • More seller take-back financing, retained equity or purchase price earn-outs to satisfy declining lender leverage ratios and to bridge seller valuation/purchase price expectations.
    • Post closing purchase price adjustments to reflect adverse changes in pre-closing net working capital or post closing EBITDA results secured by post closing escrows.
    • Extended due diligence periods to enable buyers and lenders to “drill down” for unforeseen effects of the current economic slowdown.
    • Return of traditional “financing out” condition to buyers based on credit market turmoil with fewer “reverse breakup fees” for middle market transactions.
    • Specific quantitative material adverse change benchmarks to enable buyer to “walk” from transaction without liability in the event financial and business conditions of seller deteriorate after signing M&A agreement.
    • As the result of recently litigated deals, clarity in drafting M&A agreements to provide certainty on the remedies of the parties if the deal is terminated, e.g., no specific performance rights for failure to close for any reason. Litigation may increase for busted deals or closed deals that do not perform to buyer expectations.
    • Tighter seller representations and warranties subject to qualifications, based on quantitative criteria rather than subjective “materiality” exceptions and longer survival periods for seller indemnifications, reduced “baskets”, “caps” and “collars” on indemnity claims and escrows or other security devices to secure sellers’ indemnification obligations.
    • Acquisition debt financing based on reduced leverage ratios, rigorous underwriting requirements and strict financial loan covenants. Lender imposed re-pricing of loans or other economic considerations in exchange for covenant waivers and a flight to quality by lenders in terms of collateral with less cash flow and more asset based lending. Sub-debt lenders may seek to fill the void left by senior lenders by requesting partial security with traditional higher sub-debt pricing.
  • Decreased opportunities for bankruptcy acquisitions pursuant to a reorganization plan due to scarcity of debtor-in-possession financing which will result in more piecemeal liquidations rather than sales as a going concern. More opportunistic minority equity investments in distressed companies to cure loan covenant defaults (e.g., net working capital, fixed charge coverage ratios and other financial covenants) without triggering a change of control event of default in lieu of an acquisition of a target with replacement credit facility due to the uncertainty of credit markets, risks of likely re-pricing and more stringent credit terms. Also, increased opportunities for secured party UCC sales of troubled company assets by secured lenders as alternative to time consuming and costly stalking horse bankruptcy sales.

Now, more than six months into the year, it is useful to look back at some recent deals and assess whether our predictions were accurate. As this article is part of the “Cross-Border” focused alert, it makes sense to take a look at three cross-border middle market deals that we recently closed. The remainder of this article looks at each of the three deals in turn and examines each to see which trends were prominent during the negotiations. The findings are informative because each deal portrayed a number of the predictions, but, even with the shifting of the negotiating strength between the parties, each deal successfully closed with a satisfied client.

In the first deal we represented the U.K. buyer. In the second we represented the U.S. sellers. In the third we represented the Dutch buyer. To steal a line from the old Dragnet TV show, “Ladies and gentlemen: the story you are about to hear is true. Only the names have been changed to protect the innocent.” Needless to say we found it necessary to change a little more than just the names to disguise the identities of the parties involved.

Deal One: U.K. Buyer and U.S. Sellers

Synopsis: We represented the U.K. buyer, a large private company. The target was a long-established family business based on the East Coast. The acquisition was strategic for the buyer to expand its European operations into the United States and Central America. The acquisition was for cash with no debt required.


    • Extended due diligence. The parties had been in discussions for more than a year regarding a potential deal and had a business relationship for many years prior to commencing discussions. That said, the buyer continued to carry out significant due diligence up to the last minute including a site visit and review of the target’s financials immediately prior to closing.We are finding that client’s are prepared to invest more time and money in carrying out extensive “hands on” due diligence rather than merely relying on hold-back escrows, closing balance sheet adjustments and indemnity protection.
  • Retained equity. Although the buyer was offered 100% of the business it choose to purchase 75% upfront and take an option over the remaining 25%. In addition, the buyer took an option over the sellers’ related business in another jurisdiction rather than acquire this at the outset.In the current uncertain environment our clients are insisting that sellers be fully invested in the success of the transaction. Ensuring that the seller retains an equity stake is one way to achieve this. Another is to defer some of the purchase price. In this deal, in addition to the retained equity, a large chunk of the purchase price hinged on the target achieving certain before tax profits in 2009 and 2010.

Deal Two – U.S. Sellers and U.K. Buyer

Synopsis: We represented the U.S. sellers. The target was based in New Jersey with operations across the United States. The acquisition was strategic for the buyer to expand its European operations into the United States. The acquisition was debt funded from the U.K., one of very few leveraged finance deals originating from the U.K. this year.


    • Acquisition debt financing hurdles. Although the deal successfully closed the closing was delayed when the buyer’s lenders sought last minute changes to the terms of the acquisition facility even though the facility was based on a form that the buyer had used on many occasions previously with the same bank group.In the not too distant past, buyers in U.S. and U.K. deals would typically sign a purchase agreement on the strength of a signed commitment letter from a lending group. However, in recent deals, including this one, the parties are now prepared to accommodate a longer negotiation period to permit the loan documentation to “catch-up” with the acquisition documents and be fully finalized. Indeed, buyers and sellers can better control their exposure to funding risk by insisting on executing both the definitive purchase agreement and the definitive loan documentation concurrently – we expect to see this trend continuing even after the M&A market starts its recovery.
  • Earn-Out significance. The uncertainty resulting from the troubled economic environment lead the buyer to reassess the target’s value (which was based on a multiple of earnings). This reassessment was disputed by the sellers. In order to bridge the price expectation gap between buyer and sellers, the transaction included a significant EBITDA based earn-out covering the 2009 and 2010 periods. The structure provided the sellers with an increased upside (above the price originally contemplated) should the EBITDA figures be delivered while providing the buyer with some comfort that they had not initially overpaid.The earn-out structure is well developed and can be adapted to address the buyer’s specific concerns whether they relate to revenue, profits or even individual customer accounts. As competition for deals has declined we are finding that almost all strategic M&A deals now include some deferment of the purchase price.

Deal Three – Danish Buyer and U.S. Sellers

Synopsis: We represented the buyer, an international company headquartered in Denmark, in the acquisition of a controlling interest of the equity of a New York based company. The deal was strategic for the buyer and represented their first acquisition in the United States. The transaction involved complex domestic and international legal and tax issues and shareholders agreements with future puts, calls and other buy-out rights. The buyer partial financed the purchase price by drawing down on its existing global line of credit.


    • Increased “walk” rights. After all the documents were finalized and the parties were ready to close, the closing was intentionally delayed for two (2) weeks in order to allow for a physical inventory to be taken by the seller and for revised financial statements to be produced based on the inventory results. Buyer had an absolute right to walk away from the transaction if it was not satisfied, in its sole discretion, with the results of the inventory.
  • Extended due diligence and post-closing adjustments. As with the first deal, the buyer and seller in this transaction had a business relationship for many years prior to commencing discussions. Nevertheless, due diligence continued right up until closing. In fact, the parties decided that upon closing, the buyer’s equity interest would be effective as of several months prior. Thus, the parties avoided the need for a post-closing adjustment by determining the financial status of the target and adjusting the price accordingly before closing.


We expect the predominance of middle market strategic acquisitions both within the U.S. and cross-border to continue. Despite general ruminations that the worst of the economic slowdown is now behind us, only last week (June 26) Thomson Reuters reported that in the first six months of 2009 global mergers and acquisitions saw the steepest decline since 2001, dropping a staggering 44.5% from the same period last year. With the scales continuing to weigh heavily in favor of buyers in today’s market, successful M&A transactions will depend on the creativity in structuring the acquisition and blind adherence to historic M&A models may prove to be counter productive. Successfully navigating a cross-border M&A transaction in today’s turbulent credit and economic market will require advance preparation, sound professional advice, patience and an extended time period to complete the due diligence process and, perhaps most importantly, the flexibility to adapt to the new paradigm and the evolving M&A market models and trends.