Spotlight on risk protection trends in

private M&A

Héloise Husson, Unit leader M&A, Chartis

Jay Rittberg, Vice president M&A, Chartis

Jean-Patrice Labautière, Partner, Allen&Overy

Market overview

– Analysis of the terms of recent private M&A deals on which we advised in 2011-2012

– Not legal advice !

– Extremely seller-friendly private M&A market before the credit

crunch

– Incremental movement in 2009 and 2010

– More meaningful shift in 2011-2012 to a buyer-friendly

environment

– Examples of the buyer-friendly features seen in 2011 and

2012

Increased buyer protection Cash at completion remains king

– Certain funds financing remains the norm

– Payment in full at completion is also the norm

– Instances of earn-outs borne out in a few deals

Completion accounts making a comeback in corporate sales (1)

– Private equity sellers sell on

a locked box basis

– Price adjustments in private equity

sales agreed for a specific reason

– Position in relation to corporate and

other non-private equity sellers is

more revealing

– Completion accounts are now

much more common

2008 2009

2010

2011

Locked Box

Price Adjustment

32%

68%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Corporate and other non-private equity sellers

Management accounts

Completion accounts making a comeback in corporate sales (2)

– Net debt and working capital

adjustments are frequently used

– Box usually locked on the basis of

audited accounts

– Most common limitation period for

claiming under a locked box

provision was six months from

completion

– None of the locked box provisions

included any form of financial limit Audited accounts

Net tangible assets

Net assets

Net debt and working capital

Working capital

2009

2010

20

11

Locked Box

Price Adjustment

2008

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Corporate and other non-private equity sellers

3

months

6 months

Longer

Claims

Period 7-12

months

Buyers insisting on "worst case scenario" MAC and termination rights

• Rarely seen during "pre-credit crunch" years

• This altered in 2010

• “Business MAC”

• “Market MAC” are generally carved out

• “Worst case scenario MAC“

20% 16% 8% 20%

28% 16% 4% 16% 24%

20

10

2

011 No termination rights Limited

termination rights

Termination

for material

breach of

warranty

MAC based on

specific events

24%

MAC -

financial

effect

defined

12%

Generic

MAC

12%

Carve-out for changes

in economic

conditions

78%

– Material breach

of title warranty

– Material breach

of pre-completion

covenants

Buyers insisting on "worst case scenario" MAC and termination rights (2)

– 25% diminution in value of

shares or assets of target

– Reduction in

revenues/assets or increase

in costs/liabilities of Xm in

next 12 months

– Change likely to reduce

current year profits by Xm

– Loss of two out of top

five customers

– Revocation of material

licences

– Criminal proceedings

or material litigation

– Cessation of

operations in more

than one location

20

11 No termination rights Limited

termination rights

Termination

for material

breach of

warranty

MAC based on

specific events Generic

MAC

EXAMPLES EXAMPLES EXAMPLES

12%

MAC -

financial

effect

defined

20% 16% 8% 20% 24%

Corporate sellers offering full warranty coverage

• Private equity sellers will generally only

give title and capacity warranties and a no

leakage covenant

• Management will generally give full

warranties but with limited recourse

• Corporate and other sellers give at least

"reasonable but limited" coverage

• Repetition of representations and

warranties at closing is the norm

Full

repetition

Limited

repetition

Title, capacity and

solvency warranties

repeated

No repetition

26%

2010 2011

22%

22%

50%

6%

Carve-outs to data room disclosure more common

• In previous years, extremely common for the entire

data room to be disclosed against the warranties

• Specific disclosures not uncommon

• Fair disclosure is the norm

• Carve outs to data room disclosure more common

Data room disclosed -

excluding documents….

disclosed after data….. room

closed….…

Disclosure

Data room

disclosed

34%

4% 7%

26%

15%

7% 7%

General

disclosure bundle

disclosed

Data room disclosed - no or specific disclosures against

title, capacity and solvency warranties

Specific

disclosures only

Data room disclosed – specific disclosures against identified warranties

Data room disclosed – where warranties ringfenced specific disclosures also ringfenced

Thresholds for warranty claims lower

– Difficult to determine a market practice

for de minimis levels

– In 2010, thresholds in the 1.5% to 3%

range were most common

– Levels fell in 2011-2012

– Thresholds rather than deductibles

0

200

400

600

800

1,000+

De minimis

(’000)

Threshold

(% deal value) 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0%

0 120 240 360 480 600 720+

De

al s

ize

Caps variable and time limits unchanged

– Caps for warranty claims variable but average is 25-35%

– 100% cap for the title and capacity warranties

– Time limits for claims largely unchanged (18 months)

– Time limits for claims under the tax warranties are generally applicable statutes of limitation

Cap Time limit (for non-tax warranties)

1 year

18 months

20 months

2 years

24%

52%

9%

15%

(% of deal value)

0-9% 11-19% 20% 21-29% 30% 31-39% 40% 50% 61-69% 71-79% 100%

15%

10% 10%

5% 5% 5%

15% 15%

5% 5% 5%

10%

Increasing use of escrow accounts and W&I insurance

• Escrow accounts securing warranty claims

• Escrow arrangements for other purposes

• Set off mechanisms if deferred consideration or loan notes

• Rep and warranty insurance more widespread

20%

2%

10% 9%

5% 5% 3%

14%

48

12 18

20

30

36

12

Escrow period (months)

6

Escrow amount (% of deal value)

Trends in US M&A and Role of Insurance

• Highly competitive auctions for quality businesses

• Many buyers are more risk averse after 2008 credit crisis

• Buyers that allow sellers to exit an investment with all or substantially all of their consideration at closing may have an advantage over other bidders

• Transactional Insurance allows buyers and sellers to shift deal risks to the insurance markets.

Trends in US Transactional Risk Management

• More requests for insurance and bound policies in 2012 than any year on record

• As market has matured over 15 years, more entrants have joined.

• Increased capacity allows for towers of up to $300 - $400 million

• Increased competition and increased demand has caused stabilization of rates and terms.

• Rates on line of 2-3.5% of limit.

• Retentions in range of 1-3% of deal value.

• Just 6 years ago, rates and retentions were as much as double current market levels.

Trends in US Representations and Warranties Purchasing

• Repeat Buyers Represent Greater Percentage of Deals

• Private Equity Continues to Drive M&A Insurance Market

• Other Large Scale Buyers Include:

• Individuals and VC funds selling to large corporations

• Strategic acquirers competing with private equity firms in auctions.

• Cross-border transactions

Trends in US Representations and Warranties Insurance Claims

• Some markets see claims on almost 1:4 deals.

• Millions of dollars in claims paid.

• Representations most frequently claimed against:

• No undisclosed liabilities

• Compliance with laws

• Financial statements

• Positive claims experience has allowed markets to be more competitive on certain terms

and to streamline underwriting process.

Traditional solutions in French transactions

• Additional Representations and warranties/sweeper

• Broader/larger indemnities

• Purchase Price adjustments, earn-out , reduction of purchase price

• Bank guarantee (including first demand)

• Escrow arrangement

• W&I Insurance remains an « out of the box »solution

Examples of strategical uses in France 1/3 • Auction bid : European Target (French parent)

• US corporate Bidder

• Extensive US type reps and warranties catalogue

• Italian Seller with limited credit

• Low warranty cap (1% of the VT)

Excess insurance bridged the gap to win the deal

Transaction Value

SPA threshold

SPA CAP

Transaction Value

SPA Threshold Seller’s exposure

Insurance limit

No Insurance Insurance

Escrow

Can be

reduced to

zero

Examples of strategical uses in France 2/3 • Exit of French FCPs from a US Target

• Substancial transaction value

• High cap and extensive catalogue reps on business

• French FCPs, minority shareholders

• Reps exposure limited to title and maximizing return on

investment

Insurance on title warranties provided clean exit to FCPs

Examples of strategical uses in France 3/3 • US PE fund sale before liquidation

• Target includes a French subs. closing a site

• Ongoing social litigation blocking the sale

• Foreign investor refuses to bear the risk

• Specific indemnity tailored for this risk

Insurance on specific indemnity provided certainty