The state of play: Current trends in M&A transactions
The M&A market, which initially experienced a dip during the initial wave of the COVID-19 pandemic, has witnessed a strong resurgence, resulting in a flurry of activity over the past few years.
This article considers some of the notable trends that we have witnessed during this resurgence, which are shaping the landscape of private M&A practice and impacting how parties approach deals.
There has been a notable upswing in substantial deals featuring institutional investors (including superannuation and pension funds, and sovereign wealth funds) who have been increasingly venturing into equity positions, particularly within the infrastructure sector.
Institutional investors take long term positions with assets and are looking for consistent cash flows, and long-term investment horizons. Their substantial cash reserves have allowed them to stay active, even in the face of high interest rates. Initially, institutional focus was primarily on essential infrastructure assets such as utilities, power facilities, ports, airports, toll roads, and railways. However, as these core infrastructure assets became scarcer, their attention shifted to 'value add' or 'core plus' investments. This broader category encompasses assets like data infrastructure (telecom towers, data centers, and fiber) and healthcare facilities, especially during the COVID-19 pandemic. The scope of 'core plus' assets has also expanded to include non-infrastructure investments sharing a similar investment profile, such as large agricultural enterprises.
The rise of ESG (environmental, social and governance)
ESG considerations have been gaining momentum for a while and recent transactions have demonstrated that ESG plays a significant role in every stage of the deal process.
In the early stages, ESG factors increasingly shape buyers' decision-making when evaluating potential acquisitions. Preliminary due diligence is now common, involving the review of annual and sustainability reports and undertaking public searches, to assess a target company's ESG stance.
During due diligence, identifying and understanding material ESG factors is pivotal for evaluating transaction risks and benefits. Key ESG diligence areas encompass:
- environmental concerns (including carbon emissions and waste management policies);
- work, health, and safety;
- supply chain practices;
- cybersecurity and data protection; and
- compliance with anti-corruption regulations.
In transaction documents, the extent of identified ESG risks impacts how they are addressed. Tailored representations and warranties are common, but other protective measures such as conditions precedent for curable compliance risks, indemnification and ESG-specific warranty and indemnity insurance are becoming more prominent.
Purchase price structures and challenges
It has become common for sellers not to receive the entire purchase price upon completion. One reason for this is that the buyer lacks the complete funds to make the payment. This is becoming more frequent, especially where the buyer needs to finance the purchase price and high interest rates prevent it from borrowing the full amount. To address this, buyers and sellers often enter into a vendor finance arrangement. Here, the seller essentially provides a loan for the outstanding purchase price, which the buyer must repay with an agreed-upon interest rate. Typically, the security for vendor finance is the business assets obtained by the buyer.
A buyer might also withhold the purchase price for different reasons, where:
- it pays a portion of the purchase price into an escrow account, to be released to the seller at the end of the relevant warranty period;
- there is an agreed earn-out, whereby a portion of the purchase price is paid over time after completion, contingent on the business meeting certain performance criteria post-completion.
W&I insurance has gained significant popularity in Australia in recent years. Typically, sellers provide warranties and indemnities regarding the business's state, yet these are often capped, creating uncertainty for both parties.
W&I insurance mitigates this uncertainty by covering breaches of seller warranties or indemnities, substantially reducing the seller's liability except for known issues and fraud.
Some of the other reasons for obtaining W&I include:
- Avoiding difficulties in recovering against multiple sellers: Through using W&I insurance, a buyer can simply bring its claim directly to the insurer without the need to bring separate claims against multiple sellers.
- Maintaining commercial relationships: If a seller is going to retain an interest or role in a company (e.g. sellers who maintain a management role post-completion and/or who retained some equity), W&I insurance allows a buyer to make claims directly against the insurer instead of pursuing the sellers.
- Improving a bid: W&I insurance can be used to encourage bids and provide additional comfort to bidders in competitive tender process by offering more extensive insured warranty and indemnity protections than the seller would otherwise be prepared to offer.
- Removing seller credit risk: This is particularly relevant where the sellers will be unlikely to be meet a future warranty claim. For example, most seller entities will likely distribute the sale proceeds to the shareholders and be an empty shell (and ultimately wound up), and so they could not possibly meet a warranty claim.
While W&I insurance can be extremely valuable, it is also an expensive and time-consuming exercise – and therefore better suited to medium to large sized transactions. Before an insurer will underwrite any M&A transaction, they will require extensive due diligence to be conducted on the target. Vendor due diligence can save a lot of time, but supplemental buyer due diligence is usually always required as well. In our experience, some of the key indicators that insurers will look for to ensure a thorough disclosure has been undertaken will include a formal Q&A process, access to a well ordered and complete data room, a detailed disclosure letter and due diligence report.
Having done a number M&A deals where we have acted for the seller in a competitive tender process, we have seen the importance of the seller ensuring that it has its house in order to maximise the value of the business and minimize the time it takes to do the deal.
Some specific things sellers can do in this regard are ensure:
- sale assets are held in the correct entities;
- written contracts are in place with key suppliers and customers;
- leases are in writing and registered;
- IP rights are registered where possible;
- licences and authorisations are current and being complied with; and
- employees have written contracts and employee policies are in place.
This article provides general comments only. It does not purport to be legal advice. Before acting on the basis of any material contained in this article, we recommend that you seek professional advice.
Name: Stephanie Maurangi
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