Sell-Side Middle Market Deals in the Distressed Economy

Gibbons Corporate Department has closed a number of deals on behalf of sellers since the recession began last fall. As we enter the final quarter of 2009 it is instructive to look back upon these deals to see how leverage has shifted from sellers to buyers and to spot trends which may continue over the upcoming months. In this article, we will analyze three sell side distressed situation M&A deals.

In the first deal we represented a NJ based seller in a stock acquisition by a UK fund, in the second deal we represented a seller in an asset sale to a strategic buyer, and in the third deal, we represented a seller of assets to a multi-national corporation. In each deal, we can see the effects of the recession on the sellers and we can also see illustrations of larger trends which are effecting the global M&A market. Moreover, despite declining seller leverage in markets generally, each of these clients was generally pleased with the outcome of their transaction. Good deals can still be made by sellers who show flexibility and creativity, instead of blind adherence to historical M&A models.

Deal One – NJ Sellers and U.K. Buyer

Synopsis: We represented the selling stockholders of a company which was based in New Jersey with operations across the United States. The acquisition was strategic for the buyer to expand its European operations into the United States.

Sell-Side Points:

• Be cautious of Debt Financing. The closing of the deal was unexpectedly delayed when the buyer’s lenders sought last minute changes to the terms of the acquisition facility even though the facility was based on a form that the buyer had used on many occasions previously with the same bank group. The last minute hiccup was an unexpected surprise for both the buyers and sellers who were forced by the buyer’s lenders to look closely at post-Closing cash flow.

  Debt financing of transactions is now something that needs to be addressed by both buyers and sellers at the very outset of any transaction. In the not too distant past, buyers (in both U.S. and U.K. deals) would typically sign a purchase agreement on the strength of a signed commitment letter from a lending group. However, in recent deals, including this one, the parties are now prepared to accommodate a longer negotiation period to permit the loan documentation to “catch-up” with the acquisition documents and be fully finalized. Indeed, buyers and sellers can better control their exposure to funding risk by insisting on executing both the definitive purchase agreement and the definitive loan documentation concurrently – we expect to see this trend continuing even after the M&A market starts its recovery.

• Buy Now, Pay Later. The general uncertainty resulting from the troubled economic environment is leading many potential buyers to reassess their target’s value (which is often based on a multiple of earnings). This reassessment was disputed by our sellers in the case at hand. However, to bridge the price expectation gap between buyer and sellers, the transaction included a significant EBITDA based earn-out covering the 2009 and 2010 periods. The structure provided the sellers with an increased upside (above the price originally contemplated) should the EBITDA figures be delivered, while providing the buyer with some comfort that they had not initially overpaid.

  The earn-out structure is well developed and can be adapted to address the buyer’s specific concerns whether they relate to revenue, profits or even individual customer accounts. As competition for deals has declined we are finding that almost all strategic M&A deals now include some deferment of the purchase price.

Deal Two – Seller and Strategic Buyer

Synopsis: Gibbons represented this closely-held, family-owned business in the sale of substantially all of its assets to a large, strategic buyer. The purchase price in this middle-market deal consisted of an up-front cash payment, subject only to a limited escrow. Management was retained by the buyer, including the stakeholders who will continue to run the business pursuant to terms of negotiated employment and non-competition agreements. The key assets consisted of copyrights and trade marks, for which Gibbons helped craft special representations and indemnities.

Sell-Side Points:

• Extended Due Diligence. In this deal, buyer continued its due diligence all the way through until closing, focusing specifically on confirmation of the seller’s intellectual property rights. Buyer also reviewed older records (into the 90’s) than had been customary before the recession. Protracted and extensive due diligence is a direct result of the economic slow down as buyers seek to “drill down” for unforeseen effects or hidden problems. Sellers contemplating a deal should conduct their own internal due diligence in advance. This will allow seller to have answers and supporting documents prepared, instead of scrambling to answer buyer’s questions.
• No Debt Financing. Buyer in this deal was able to avoid bank financing, and instead, drew the purchase price from its own cash reserves and a minority financing partner. This deal illustrates a larger trend that shows a greater percentage of purchase price consideration paid in cash/stock of buyer, rather than from proceeds of debt financing.
• Tighter Indemnification. This deal involved extensive negotiation on the terms of seller’s indemnification of buyer. Ultimately, the “baskets” and “caps” were consistent with historical market levels for comparably sized deals. However, the buyer’s focus on the indemnification provisions reflect a trend whereby buyers seek to secure their value and sellers’ indemnification obligations.

Deal Three – Seller and Multi-National Buyer

Synopsis: We represented a family-owned business in the sale of substantially all of its assets to a large multi-national buyer in the food commodity business. Prior to the purchase, the buyer was an active customer of the seller and sought a strategic acquisition to both lower its production costs and increase its presence in the State of New Jersey. The owners of the business were retained by the buyer to ease the transition and continue to run the business for a few years following the closing. Once again, the purchase price in this middle-market deal consisted of an up-front cash payment, subject only to a limited escrow.

• Extended No-Shop Diligence Period. Similar to the protracted diligence reported in Deal Two above, the buyer in this transaction underwent approximately four months of due diligence prior to presenting an initial draft of the purchase agreement. Diligence continued right through to the closing in increasing levels of detail. In the final stages of the transaction, teams of buyer’s employees were spending entire work weeks in the seller’s facilities. Throughout the diligence stage, buyer insisted that seller remain subject to an exclusive no-shop provision. Although we were successful in limiting the term of the no-shop to short increments to keep pressure on the buyer, it was amended numerous times throughout the pre-closing transaction to give buyer more time to thoroughly investigate all aspects of the seller’s business.
• Non-Competition. Despite the fact that seller’s operations and contacts were located solely in NJ and that the owners and managers of the seller were being retained by the buyer after the closing, seller’s concern over a reduction in the potential value of its purchased assets led to heavily negotiated non-competition provisions of varying geographic scope and time periods in both the employment agreements of the owners and in the purchase agreement itself.
• Tighter Indemnification. We expected that buyer’s comfort with the business of the seller due to its extensive diligence would result in a more lenient indemnification provisions. Nonetheless, continuing the recent trend noted above, the amount of the purchase price required to remain in escrow and the indemnification provisions were very heavily negotiated. We note that once again the ultimate “baskets” and “caps” were consistent with historical market levels for comparably sized deals.

Conclusion

Middle market M&A opportunities exist for sellers, provided sellers recognize that generally speaking historic “market” terms have shifted in favor of buyers. Sellers and their advisors need to be creative in meeting buyer’s concerns during this credit crunch and general economic slowdown. Today’s deals face increased hurdles imposed by lenders; or in lieu of bank financing, may require greater use of seller financing, earn-outs or post-closing price adjustments. Today’s buyers are nervous about realizing their projected value from the deal. Accordingly, the buyers will push harder on due diligence and will negotiate for increased “walk” rights in case they decide not to close the acquisition. However, as the deals profiled in this article illustrate, sellers can still successfully sell their business with some advance preparation, sound professional advice, patience and focus.