At Morse‘s 2019 VC and M&A Forum on May 2, panelists with their finger on the pulse of the M&A world shared their views as to current trends in M&A deal terms. Moderator John Hession, Partner at Morse, led a discussion among data maven Amanda Jackson Managing Director – Eastern Region, Business Development at SRS Acquiom, investment banker Paul Bowen, President at Bowen Advisors, and corporate and tax attorney Dave Czarnecki, Partner at Morse. For the most part, the trends were seller favorable, as PE funds and strategic buyers compete for great deals, and as innovations in the market like rep and warranty insurance get cash in the sellers’ pockets sooner.
Economics. A highlight from the past year: deal sizes are up. Spurred in part by significant PE activity – private equity funds are both buying companies directly and backing strategic buyers – both the sizes of deals and the valuation multiples are up. Paul called the multiples they’re seeing, especially for SaaS companies, “shocking,” with 7x or greater multiples for larger SaaS companies not out of the question.
Earnouts and Contingent Payments. Based on the current data, sellers should beware of earnouts and contingent payments. About 45% of the time, no earnout is paid, said Amanda, and in the other 55% of cases, many of the payments are only partial earnouts. The panelists’ advice: avoid earnouts where possible and maximize cash up front. If there is an earnout, Paul advised, make it R&D or product deliverable-based, not revenue-based, as R&D and product development are more in the hands of the original management team.
Net Working Capital Adjustments. Perhaps driven by the financial engineers at the PE funds, the net working capital adjustment has become more important than ever before. More that 75% of deals have a net working capital adjustment mechanic. Dave advised companies to hire great advisors, as the accounting minutia becomes very important here.
Indemnification and Escrow. Panelists agreed that the growing popularity of rep and warranty insurance has transformed this area of M&A practice. Rep and warranty insurance is “one of the great innovations in M&A over the last five years,” said Paul. It’s becoming more and more common to have small or even no escrows, giving stockholders more cash up front. 2018 showed a big growth in the number of deals with escrows of less than 5% of deal consideration, Amanda said. It’s also becoming more common to have public-style deals with no escrow. When there is an escrow, it’s highly likely that all or close to all of the escrow amount will go to the sellers – they just need to wait the 12-24 months for it. Another piece of good news for sellers – it’s extremely rare for claims to go above the escrow. Only two out of the last 1,000 SRS deals were settled for more than the escrow amount, said Amanda.
Baskets and Deductibles. More good news for sellers – the number of deals with true deductibles, as opposed to tipping baskets, is increasing, showing up in 50% of deals in 2018, up from 30% three years ago, according to SRS data. The basket is usually 1% or less of the deal size.
Bottom line? Companies with strong performance are well posed to ride these trends to a favorable M&A outcome.
We hope you enjoyed our 2019 VC and M&A Forum panel recaps. Be sure to keep an eye on our events page for future events!