M&A Outlook and Key Deal Terms Trends
- Jon Taylor
- October 31, 2023
Our friends at SRS Acquiom recently released the “2023 M&A Deal Terms Study” showcasing data highlights and deal terms trends from more than 2,100 private mergers and acquisitions that closed between 2016-2022 as well as findings from early 2023. In mid-October, KO partner Jon Taylor joined SRS experts Kip Wallen and Ana Samarjian to discuss key trends in the study and recent real-world experience negotiating M&A deals. Below we recap some observations about the M&A landscape and key trends along with the full study and webinar recording.
The M&A Landscape in 2023
2021 was a robust, outlier year where significant competition amongst buyers led to seller favorable terms. In 2022, financial buyers, particularly private equity-backed buyers, remained active even as valuations began to soften. In 2023, public and private strategic buyers have been less active while conserving cash and instead we’ve seen more opportunistic buyers and more distressed M&A deals. We’ve continued to see an increase in transactions under $25 million from 2021 through 2023. In 2023, buyers are spending more time on due diligence and deals are taking longer to close, resulting in uncovering more potential post-closing matters and claims that may arise.
Transaction Values and Structures
As the M&A market adjusts to the economy and we see more smaller transactions, in some cases there may be less incentive for buyers and sellers to heavily negotiate terms given the smaller transaction size. However, in many cases, smaller transactions can be more complicated because cash, equity, management carve out plans, and earnouts may be part of the deal in an attempt to increase the price and make the deal attractive to both sides.
In 2022, 23% of deals were a stock/cash combo, 4% were all stock, 54% were all cash, and 20% were cash and management rollover. In 2023, we’re continuing to see an upward trend of buyers using their equity in combination with cash or in some cases all stock deals. For both buyers and sellers it is important to determine how to value the equity upfront, especially if the equity is tied to an indemnification claim.
Today we’re seeing bigger, more complicated earnouts as well as more customized and larger escrow accounts. Earnouts mean some portion of the deal is contingent on post-closing performance, metrics, or milestones. While historically a minority of deals have had earnouts, we’re seeing a higher prevalence of earnouts in 2023. In some distressed deals, there’s a very small payment at closing and most of the consideration may be tied to an earnout. While sellers understandably try to avoid an earnout, it’s a tool for buyers to ensure the value of their purchase and for sellers to achieve a higher payout if the earnout is hit.
The size of earnouts increased with the pandemic in 2020 and they are on track to increase again in 2023. Earnouts can generally be more successful if tied to a shorter period of time when the management team or key personnel from the seller continue to be involved in the business and are motivated to help the buyer achieve the earnout. During negotiation, it’s important to carefully draft and clarify thresholds, reporting rights, define commercially reasonable efforts, and identify who determines a dispute.
Purchase Price Adjustments
Five to ten years ago, purchase price adjustments (PPAs) used to be a one-way mechanism that would typically only benefit the buyer. Today, they are included in 94% of private M&A deals and are a two-way adjustment mechanism for both buyers and sellers. Oftentimes PPAs are used when a company doesn’t know its working capital or cash position due to pending accounts receivable and other factors.
Typically, the seller will prepare the initial estimate and the buyer will have a chance to review it. In 11% of transactions, buyers have a contractual right to review the estimated PPA calculations. Ideally the PPA is determined early and in a way where no one is surprised.
Tune in to the full webinar recording below and check out SRS Acquiom’s presentation for more information including:
- Trends in indemnification claims and RWI usage
- More on management carveouts, earnouts, tax representations
- How intellectual property affects a deal
- Real-world examples of how to avoid post-closing M&A challenges and more.
Trust and Careful Drafting Go a Long Way
In today’s economy, it’s more important than ever for buyers and sellers to understand how to position themselves for favorable M&A transactions. Every M&A deal is unique and nuanced with stakeholders invested in protecting their interests. Today’s climate and recent deal terms trends reinforce the importance of establishing trust between the buyer and seller as well as careful drafting early in the M&A process.
Jon Taylor is a corporate partner at KO Law Firm who specializes in corporate and securities law with more than 25 years of experience in emerging company issues, venture capital, M&A and private equity. Jon is passionate about working with entrepreneurs on everything from formation through multiple rounds of financing and eventually ending with an exit transaction. Reach Jon at [email protected].