Understanding Buyer Power In Negotiating M&A Deals | Transaction Advisors

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At Transaction Advisors M&A conference at Wharton San Francisco Hogan Lovells Partners, Richard Climan and Keith Flaum illustrated the give-and-take between buyers and sellers in negotiating key provisions in M&A deals.

Particular focus was given to pricing formulations in stock swaps and “earn-out” transactions as well as the growing tendency of M&A dealmakers to “negotiate by the numbers” – to rely (and perhaps over-rely) on widely proliferated market statistics in staking out their negotiating positions.

In an M&A transaction, the two most common forms of acquisition currency are cash and buyer stock. While cash tends to facilitate a simpler transaction, a stock swap transaction gives a target tax-deferral benefits.

The presenters illustrated that when buyer stock is used as the acquisition currency, a target will likely seek some level of access with respect to the buyer’s financials in order to perform diligence and evaluate the buyer’s forecasts. Depending on the ownership stake the target is receiving in the buyer, the buyer is likely to push back on such requests.

Depending on the circumstances in a stock swap deal, the parties will choose between a fixed exchange ratio or a fixed dollar ratio.

A drop in the buyer’s stock price between signing and closing in a fixed exchange ratio deal would adversely affect the target. In a fixed dollar ratio deal, the same drop in price would adversely affect the buyer.

In a fixed dollar ratio deal, if the stock price dropped significantly between signature and closing, it’s possible a target would ultimately acquire a large enough ownership percentage in the buyer that a stockholder vote on the transaction would be triggered.

Adding a “collar” to cap the maximum number of shares a target can receive can mitigate this risk.

The discussion also addressed how an earn-out allocates a portion of the purchase price to be paid post-closing based on the post-closing performance of the target.

Parties tend to view earn-outs as a creative way of bridging valuation gaps; however, negotiating the earn-out can often take a significant amount of time and lead to disputes or even litigation.

Parties to a deal must determine what metrics to base the earn-out on, whether it be top line revenue metrics or bottom line metrics, such as EBITDA, in addition to deciding what events, if any, will accelerate the earn-out payment.

The panel also cautioned against overreliance on deal point studies as such studies are based solely on deals filed with the SEC.

Deals completed by serial acquirers with big market caps are not typically reported to the SEC; therefore; the deal point studies are not informative when negotiating with such an acquirer.

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