What are the main differences in M&A transaction terms between acquiring a business from a trade seller and financial sponsor backed company in your jurisdiction?
Private equity sellers tend to prefer locked box structures (see question 5).
While well advised trade sellers usually prefer locked box structures as well, closing adjustments are more frequently agreed with trade sellers than with private equity sellers.
Experienced private equity sellers will try to avoid business warranties and indemnities (and instead just provide warranties on title and capacity). In addition, experienced private equity sellers will be very keen to limit recourse for warranty claims (e.g. to an amount paid into escrow) as well as any other post-closing liability.
Where private equity sellers are forced to give business warranties, they will seek back-to-back warranties from management and underwrite a seller’s warranty and indemnity insurance policy or offer the buyer management warranties instead (which are usually linked to a buyer’s warranty and indemnity insurance policy). The latter structure has the benefit that the private equity seller will not have to concern himself with post-closing warranty litigation.
In contrast to this, it is fairly common for trade sellers to give business warranties without a warranty and indemnity insurance.
Private equity sellers will try to limit post-completion covenants to access books and records and sometimes assistance in relation to pre-completion affairs. Usually, all buyers will insist on non-compete and non-solicitation covenants (which private equity sellers will typically try to resist). Trade sellers are usually more likely to offer and accept post-completion covenants.
Financial sponsors usually dispose of assets through a controlled auction. Financial sponsors favour the locked box approach, allowing a clean exit and providing the possibility to distribute the consideration more quickly. The absence of any post-completion adjustment eliminates the need to hold back funds in case adjustment works against the seller. Financial sponsors are sometimes only prepared to give limited “fundamental” warranties (i.e. due existence, due authority and title to shares), in particular in secondary buy-outs.
As sellers, financial sponsors tend to avoid any post-closing exposures and to limit post-closing covenants and indemnification terms. Limitations on indemnification include short survival periods for representations and warranties (sometimes such survivals are less than a year after the closing) and incorporating de minimis, deductible or basket and cap thresholds or amounts with respect to indemnification payments. Cap amounts negotiated by financial sponsors are often lower than those negotiated by trade sellers.
Structures set up in Mauritius tend to be holding structures for the entities operating in other jurisdictions, e.g. in Africa or India. Consequently, acquisitions from trade sellers will be in the form of an interest in the holding company set up in Mauritius. Financial sponsors usually set a new "platform" holding company that serves as the parent for the new target and any operating companies subsequently acquired. The holding company's sole purpose is to hold the securities of the operating company(ies) that are acquired by the financial sponsor. Consequently, at the time of divestment, the financial sponsor will divest either the holding company unless the sale is at the level of one or two operating companies only.
Currently, there are only minor differences in M&A transaction terms between acquiring a business from a trade seller and financial sponsor backed company in the Norwegian market.
Financial sponsors have traditionally been somewhat more resistant to provide comprehensive representations and warranties in share purchase agreement than trade sellers. With the breakthrough of W&I insurance in the Norwegian market around five years ago, which nowadays is used on almost all sales process conducted by financial sponsors, they are, however, able to offer the same representations and warranties package to the buyers as trade sellers.
Aside from that, financial sponsors are generally less willing to take on any residual liabilities under the share purchase agreement, such as specific indemnities, than trade sellers. Financial sponsors often need to liquidate their holding structure in Norway and abroad to repatriate proceeds in a tax efficient manner. A full liquidation may however often not be possible if the liquidating company has outstanding contingent liabilities remaining under the share purchase agreement.
The key difference we see is that financial sponsors are often more reluctant to give representations and warranties or indemnities than trade sellers. The two main reasons for this difference are in our view the following: First, financial sponsors' aim to have a clean exit with limited (potential) outstanding liabilities in order to be able to distribute the exit proceeds to the investors. Second, financial sponsors are, by trend, less involved in the day-to-day business of the target group and, therefore, not in the same position as trade sellers to assess potential risks.
Financial sponsors will seek a clean exit and more often dispose of assets through a controlled auction. This is one of the reasons that financial sponsors favor the locked box approach, providing the possibility to distribute the consideration more quickly. The absence of any post-completion adjustment eliminates the need to hold back funds in case adjustment works against the seller.
For the same reasons, sometimes financial sponsors are only prepared to give limited “fundamental” warranties (i.e. due existence, due authority and title to shares). Therefore, increasingly buyers of businesses that are owned by financial sponsor are taking out warranty and indemnity insurance to ensure that (full) operational warranties can be obtained backed by appropriate financial protection.
Financial sponsors need to achieve a clean exit which allows them to upstream a clearly defined amount of proceeds from the transaction to their investors. The clean exit approach is important for both the purchase price mechanics and the warranty and indemnity coverage given by sellers. Most exits from financial sponsors are structured on a ‘locked-box’ basis with an effective date prior to signing and no purchase price adjustments or earn-out mechanisms. Also, in most sponsor deals, the buyer receives very limited fundamental warranties (i.e. authority, capacity and title) with the optionality for the buyer to take out a W&I insurance for operating warranties (which is often provided as a stapled product in auction processes (i.e. procured by the seller and paid for and incepted by the purchaser).
We hardly see any forms of indemnity being offered unless there is a tax indemnity the sole recourse for which is against a W&I insurance policy.
The time limitations for all other claims are very short.
Financial sponsors need to achieve a “clean” exit which allows them to upstream a clearly defined amount of proceeds from the transaction to their investors. The clean exit approach is important for both the purchase price mechanics and the warranty and indemnity coverage given by sellers. In many deals involving an acquisition from a financial sponsor seller, buyers receive very limited fundamental warranties (i.e. authority, capacity and title) with the optionality for buyers to take out a W&I insurance for operating warranties.
By contrast, in an acquisition of a business from a trade seller or from the Chinese founder(s), it would be more customary for the seller to agree to give a wide range of business-related representations and warranties and/or indemnities addressing specific issues uncovered during the due diligence. An acquisition of a business from the Chinese founder(s) is also more likely to include an earnout based on the performance of the company following the closing, which is almost never seen in an acquisition from a financial sponsor.
Financial sponsors tend to prefer a locked-box pricing mechanism to closing accounts, particularly when on the sell-side. Moreover, deal certainty is a decisive factor for financial sponsors resulting in minimum conditions precedents. The typical closing conditions include merger clearance (if applicable), other sector-specific clearances and deal-by-deal negotiated requirements. Financial sponsors typically endeavour to achieve a ‘clean exit’ with only limited fundamental warranties given by the seller, especially as the use of (buyer-side) W&I insurance has become common in Finland. While the management may provide more extensive warranties than the financial sponsor seller, typically all sellers are treated equally in the sale and purchase agreement due to the drag-along provisions in the sellers’ shareholders’ agreement often requiring equal treatment of all sellers.
Given that the use of W&I insurance is not standard practice in the French market (see question 7 below), the representations and warranties provided by financial sponsors are generally limited to core warranties, i.e. title to shares, capacity, authority and insolvency. On the other hand, the scope of the representations and warranties granted by the trade sellers is substantially wider and will cover operational matters (e.g. compliance with laws, employment, taxes etc.).
Almost all transactions involving financial sponsors are based on locked box mechanisms whereas trade sellers continue to use completion accounts. However, the use of lock box mechanisms is more and more frequent in trade sales as well.
Financial sponsors, unlike trade sellers, will also refuse non-compete or non-solicit undertakings so as to avoid any constraints in their future acquisitions.
Finally, because they want to stream up the proceeds as soon as possible after completion of the transaction, financial sponsors tend to refuse to assume any residual liability vis-à-vis the purchasers. As a result, specific indemnities are quite rare. Financial sponsors will also be reluctant to put in place escrow accounts to guarantee the payment of any indemnification amount.
Financial sponsors need to achieve a clean exit which allows them to upstream a clearly defined amount of proceeds from the transaction to their investors. The clean exit approach is important for both the purchase price mechanics and the warranty and indemnity coverage given by sellers. Most exits from financial sponsors are structured on a ‘locked-box’ basis with an effective date prior to signing and no purchase price adjustments or earn-out mechanisms. Also, in most sponsor deals, the buyer receives very limited fundamental warranties (i.e. authority, capacity and title) with the optionality for the buyer to take out a W&I insurance for operating warranties. We hardly see any forms of indemnity being offered unless there is a tax indemnity the sole recourse for which is against a W&I insurance policy.
The time limitations for all other claims are very short - we have recently also seen a "no survival of claims" (i.e. with regard to covenants and other obligations under the transaction documents) concept following the closing which has been imported from the US.
M&A transaction terms do not differ significantly in terms of the seller’s nature as a financial sponsor or trade seller, although this may have an impact on the pressure a seller has to close the deal (i.e. a financial sponsor who is close to the liquidation phase).
That being said, the most important difference are any transaction loose ends and seller’s potential post-closing obligations. A financial sponsor will usually require a clean exit.
Deferral of payments or escrow mechanisms (i.e. for future liabilities) will usually be resisted – albeit not necessarily rejected - by a financial sponsor (in fact, in some cases an escrow agreement is the prevailing alternative to address post-closing liability of the seller - i.e. if the seller is a special purpose vehicle). Moreover, sellers post-closing obligations (i.e. non-compete) differentiate depending the nature of the seller. A buyer will be more emphatic in asking a non-compete from a trade seller that operates in, or is related to, the target’s industry; at the same time a financial sponsor will not undertake any such obligation which will be restrictive either to the financial sponsor or to any entities the financial sponsor’s is currently or in the future related to.
Very much the same as in the UK. No substantive business warranties, usual to have W&I insurance and if there is an identified contingent liability, a small escrow pot.
The differences in approach between a trade seller and financial sponsor backed entity are not specific to the Luxembourg market.
In general, financial sponsor backed sellers are reluctant to grant anything other than the basic warranties (i.e. warranties as to their own ability to enter into the transaction documents and perform thereunder and title to shares).
It is also less common to have delayed escrow payments or earn out mechanisms in such transactions as, typically, such sellers wish to complete the sale as promptly as possible and distribute the consideration to ultimate holders.
Merger clearance is compulsory in case the relevant criteria, in particular turnover and balance sheet – related thresholds, are fulfilled. Filings for approval of agreements on joint activities of competitors can be made voluntarily in case the thresholds are not reached.
It is important to set out the reality of Polish M&A transactions at the outset.
In certain jurisdictions, there is a marked difference in the terms that are offered in comparable deals, depending on whether the seller is a trade seller or a private equity fund.
Private equity funds often give substantially curtailed seller protections, for instance.
Polish M&A is different. Here crucial issues are the negotiating power of the various parties and, in particular, the sophistication of their advisers. So in a situation where two leading M&A law firms are retained, the result may be a shared understanding of certain deal parameters and a shorter negotiation process, comparable to a English law transaction elsewhere.
In circumstances where these parameters are not present the rule is “what you negotiate is what you get”. Accordingly, there is a wide degree of variability in deal terms.
A financial sponsor in Portugal will usually privilege a “clean” exit (with as little exposure to risk as possible) from their portfolio companies; in such an instance the relevant acquisition agreements will typically feature limited representations and warranties given by the seller and may sometimes involve the contracting of “warranties and indemnities insurance” (which is currently gaining traction in Portugal) with an insurance company specialized in originating such policies. To avoid the risk of unit holders/limited partners being exposed to liability after the dissolution of the sponsor’s investment vehicle (when the financial sponsor acts through fund or other type of collective investment undertaking), private equity sellers also often agree to place money in escrow accounts to fund any liabilities which may arise from breach of representations and warranties or other contractual obligations.
On the other hand, a trade seller will often be more interested in maximizing proceeds from the sale, even at the expense of more adverse terms and conditions in the relevant acquisition agreement. This will be reflected in more extensive representations and warranties, “laxer” limitations on indemnification and occasionally the acceptance of specific indemnities.
A financial sponsor more often uses a controlled auction and has a more strict view on terms such as that: (i) the buyer must assume the whole merger clearance risk; (ii) there will be no conditions precedent to completion; (iii) the sponsor backed company will not offer any representations and warranties unless the buyer takes out a warranties and indemnities insurance policy (“W&I insurance”). Almost all PE backed exits will require the buyer to take out W&I insurance.
Financial sponsors need to achieve a clean exit which allows them to upstream a clearly defined amount of proceeds from the transaction to their investors. The clean exit approach is important for the warranty and indemnity coverage given by U.S. sellers. In order to address this most sales by financial sponsors are structured with: (i) standard purchase price adjustments based on net debt and target working capital items but with sole recourse to an escrow amount for downward purchase price adjustments; (ii) fundamental and operational warranties tend to be covered by R&W insurance; and (iii) the time limitations for all other claims (if any) are very short.
In our experience, the most notable difference between an M&A transaction involving a trade seller on the one hand, and a transaction involving a financial sponsor-backed company on the other hand, is that a financial sponsor-backed company tends to have a very clear and structured methodology in its approach towards a sale, having clear parameters and objectives that are in-keeping with the financial sponsor’s financial, commercial and/or strategic objectives which have a tendency to be clearly defined and set. Thus, for instance, the initiation of the sales process through the preparation of a Vendor Due Diligence report enables the financial sponsor to kick-start the sales process quickly and effectively, shortlisting potential purchasers possessing the right qualities in a more structured and objective manner. This highly methodical approach to deal-making makes the transaction more streamlined and efficient, setting private equity transactions apart from other M&A deals.
By contrast, trade sellers do not typically have any specific methodologies in their approach to the sale of the business, even in the case of serial entrepreneurs who may have sold various businesses in the past. Trade sellers tend to brings a host of other elements into play in the transaction, which could include personal, emotional and philosophical underpinnings that invariably have the tendency to complicate the management of the transaction. These issues are typically exacerbated somewhat when the sale is not an outright sale but the dilution of the trade seller’s interest in the business, creating various considerations relating to management and control. In such circumstances it is critical that advisors of a trade seller take a leading role in managing the transaction to ensure that objectives are identified and clearly established from the outset, reducing the risk of having external factors having a significant bearing on the course of the transaction.