Seller power and risk drive changing M&A behaviour, finds report

Analysis of £32 billion worth of mid-market M&A deals in 2017 by Pinsent Masons, the law firm behind Out-Law.com, and insurer Howden, indicates that the current market benefits sellers as abundant capital chases a limited number of opportunities.

M&A expert Edward Stead of Pinsent Masons said that the 2017 trends have continued into this year.

The report said that a strong sellers' market would usually lead to sales by auction as sellers look to maximise prices. But the use of auctions fell last year, with buyers prepared to pay a premium to avoid a competitive process.

"With limited resources private equity houses have to choose where to invest their time and certainty is highly valued, which perhaps goes some way to explaining this trend," the report said.

Sellers are using their dominant position to decrease their exposure to risk, the research found. Almost all of the transactions had caps on sellers' warranty liability. In deals with private equity investors the competition for assets meant that private equity buyers accepted a low liability cap of under 25% of the deal value.

"This reflects the fact that private equity investors have been seeking to deploy capital in a highly competitive sellers’ market and, in order to win business, they have had to offer seller friendly terms in respect of liability caps," the research said.

Buyers are in turn hedging their risk through the increased use or at least consideration of insurance against warranty and indemnity (W&I) insurance.

"Private equity investors seek additional comfort through a combination of warranty and indemnity insurance, extensive due diligence and the level of rollover investment being made by management warrantors," said the report.

W&I insurance was considered in 26% of the deals analysed, and used in 15% of the deals.

Risk is also playing a part in the way that buyers are structuring deals, the research found. The use of 'material adverse changes' (MAC) clauses has increased, reflecting a nervousness about wider economic and political uncertainties.

"With the increase in uncertainty due to the ongoing Brexit negotiations and the higher prices that buyers are paying, buyers are being more demanding when it comes to the risk profile they are prepared to accept. This is reflected in the greater use of MAC clauses," it said.

Stead said that these trends are ongoing. "Based on the levels of M&A and private equity investment activity we are presently seeing we anticipate the 'sellers’ market' conditions will continue in 2018 and that will lead to a continued downward trend in the aggregate financial liability caps that sellers are able to achieve in sale agreements," he said.

"I also think warranty and indemnity insurance will continue to be used, or at the very least considered, on a very significant proportion of transactions in 2018 given the number of underwriters now offering terms and its competitive pricing," he said.

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