Mastering M&A markets

The market for mergers and acquisitions in Ireland is picking up and there are a lot of deals to be done. But if you want to get the best results, you’re going to need the best advice, as Gerry Halpenny explains.

Ireland’s mergers and acquisitions (M&A) market is showing signs of recovery. Despite recent data showing a drop in the number of Irish transactions compared with this time last year, there are still plenty of deals being done and prospective buyers are quite active in the market. In addition, sellers who held off selling following the crash have now become more realistic in their expectations and so are more willing sellers.

We have noted significant activity in the pharma/medical, telecoms, energy, internet, financial and food/food services sectors in 2013.

There is increased interest from overseas investors, and the market is likely to be driven by the acquisition of distressed assets, receiver sales and restructuring with banks and NAMA. The majority of acquisitions remain funded by larger corporates, mostly non-Irish, who have the resources to fund deals without needing to borrow.

Ireland’s commitment to a low rate of corporation tax continues to work in our favour as a significant driver of inward acquisitions in both the public and private sphere, as foreign companies seek to establish a base in this country. Recent public company examples are the Eaton/Cooper and Perrigo/Elan deals.

The perceived undervaluing of assets and the opportunity to restructure debt, save businesses and save jobs are encouraging management teams and investors to negotiate with NAMA for distressed assets. There are finally signs of increased availability of debt financing, particularly through global investment banks and NAMA seller financing.

With increasing activity and the growing need for a global perspective when negotiating the sale or purchase of a business in Ireland, it is important to be aware of some of the characteristics that drive the shape of deals done in the Irish market.

Mind the gap

In many other jurisdictions, local requirements dictate that the signing of an acquisition agreement and closing of the deal do not happen simultaneously. That is not the case in Ireland, where it is possible in the vast majority of cases to sign and complete at the same time. The need for a gap should arise only where there is an external approval required that cannot be sought until an agreement has been signed, such as competition or other regulatory approval or the execution of documents by third parties.

Any condition which is internal or discretionary to the purchaser (such as board approval) should be resisted by the seller, because it effectively changes a purchase agreement into an option in favour of the purchaser.

A gap places additional burdens on the seller. During the gap period, restrictions are likely to be placed on the activities of the target, which protect the purchaser’s interests but which may not necessarily be in the best interests of the target should the deal fail to complete for any reason. Usually, the seller will be required to warrant the state of the business both at signing and again at completion, so it is required to do something that is never particularly attractive, which is to warrant a state of affairs at a future date. So a seller should refuse to agree to a gap unless it is absolutely unavoidable.

Consideration adjustments

Years ago, it was pretty simple. The seller and purchaser agreed a price, a purchase agreement was signed and the deal completed. Usually there was a warranty in the agreement as to the level of net assets, together with the usual warranties on the target company accounts and as to the operations since the date of those accounts. Nowadays, it’s a bit more complicated.

In all but the very smallest deals, purchase price adjustments are common by reference to a set of accounts prepared as at the date of closing the deal. These ‘completion accounts’ are used to calculate adjustments by reference to items such as net cash/debt, normalised working capital and net assets. Another test often seen is cash-free, debt-free, which sounds simple enough, but there can be disputes about what is included in those terms, mainly debt, where the discussion usually centres on whether finance leases are included.

Occasionally, where the price has been calculated as a multiple of EBITDA (earnings before interest tax depreciation and amortisation) or some profit measure, the completion accounts will also be used to verify the level of EBITDA.

Given that a multiplier will apply, any variance from the expected levels of EBITDA can produce a significant adjustment to the price so it is vitally important for the seller to be confident in the financials of the target and for the purchaser to be able to conduct a full audit-like review of the figures. Adjustments by reference to assets or liabilities will be on a euro for euro basis, but can also result in significant changes to the price.

What are called ‘earn-outs’, where part of the purchase price is paid in the future by reference to future performance of the target, have been part of the M&A landscape for many years now, having become popular in the late 1980s.

The principal purpose of an earn-out is two-fold. First, it allows the purchaser to hedge its bets somewhat, as it will only become liable to pay what could be a significant part of the price once it knows that the target is trading well. Second, where the seller or sellers are individuals staying with the company, the earn-out provides an incentive for them to maximise profits. As the purchaser will be in control of the target and the preparation of the future accounts by reference to which performance will be measured, protections must be built into the purchase agreement for the seller regarding the future operations of the business.

Escrow arrangements

More common in US deals, escrows involve depositing cash with an independent third party pending determination of any outstanding issue. This cash can only be released upon determining any consideration adjustment or to compensate for warranty or indemnity claims by the purchaser. Escrows are in almost all cases an advantage for the purchaser, as it knows that funds are available to meet any payment obligation of the seller.

Escrows are unusual in Ireland and are normally only seen where potential liabilities have been identified which are obligations of the seller, or where there is a doubt about the creditworthiness of a seller or sellers after closing, such as where a seller is a special purpose vehicle which will disappear after the deal is done. In the USA, it is typical that a percentage (usually between 10% and 20%) of the consideration is locked in escrow, but the escrow amount is also the only recourse for most claims. In Ireland, the cap on liability is invariably higher, ranging from a percentage or portion of the consideration (rarely less than 50%) to the full amount of the consideration. Other than in the specific circumstances mentioned above, the seller should resist the concept of escrow, and certainly where the cap on liability is all or a majority of the consideration.

As the market picks up and global deals come to the fore, negotiating a good deal requires experience in the field and knowledge of what terms sellers and purchasers will be willing to accept. Inevitably, much depends on the relative bargaining position of the parties and the experience of their advisers. It is becoming increasingly important for parties to receive commercial and pragmatic business advice as transaction documents become ever-more complex; much time can be wasted discussing and negotiating provisions that may never have any practical application.