03 May Getting Out of Deals with Material Adverse Change
A recent article in the NYT DealBook by Stephen Davidoff underscores the need for pre- M&A planning when it comes to the negotiation table. He cites several high-profile examples, including a current tussle Pep Boys is having with Gore Private Equity over whether the less-than-expected profits in recent rounds constitutes a MAC (material adverse change) in the contract. If so, Gore may be able to get out of the deal by simply paying out a 5% reverse termination fee, which in their case is a $50 million sum. Recent history indicates that PE firms especially are paying the money and running. But let’s take a look at the options for both the target and the acquirer in this instance.
From the target’s perspective, the show must go on. They will do anything within their power to make sure the deal is pushed through. The author cites a famous case in which Dow Chemical was forced into the acquisition of Rohm and Haas right in the middle of the financial crisis at a valuation that was paltry to what was initially anticipated, based on the sink hole that was the entirety of the market at the time. This is the ideal opportunity for a target company to have: no downside risk. If you read the details of the Rohm and Haas acquisition, executives stood to profit handsomely from the deal and had all the more incentive to push it through.
Unfortunately, this is more of the exception rather than the rule. If a deal goes sour, and they sometimes will, then termination fees are paid and acquiring companies often will take a hike. In anticipation of such a blow, many companies have forced increases in the once standard 3% termination fees, now requiring even higher 4% and even up to 8% for a potential break-up.
What the buyer wants is often highly dependent on the type of buyer you are dealing with. A private equity firm will be less likely to negotiate. In the event the deal goes south with a more strategic acquirer, there are often other options. In the case of a PEG, they may use all the chips it has to secure an exit from the deal completely, especially if the “adverse change” is highly adverse.
The first step in this process is to use the MAC claim. When this occurs the acquiring company may not necessarily want out of the deal, but it usually signals the start of negotiations which could amount any number of options including: renegotiated terms of the termination fee (or if there is really a need for a termination fee based on a MAC) or renegotiated corporate valuations.
In any event, the small nuances at the outset of any deal can have very large percolating consequences, especially with the current volatility of things. Uncertainly breeds fear and fear may make anyone want to run as fast as they can away from a bad thing. This may be one reason to work to ensure your company has steady cash flow coming in and a very viable future before it gets shopped around, especially to private equity firms.