In This Issue
BEST PRACTICES
Helping Parties to Mergers Assess Risk and Negotiate Smarter Deals
In order to better assess risk and negotiate smarter deals when buying or selling a private company, parties should ask: what really happens after closing?
LIFE SCIENCES FOCUS
From Partner to Buyer - Different Model, Same Challenge
For life sciences startups, the ability to manage relationships with larger partners has always been a key factor in their success.
INDUSTRY INTEREST
When and Where Buyers Acquire May Hinge on a Tax Holiday
A proposed tax holiday offering corporations relief from U.S. repatriation tax could impact which startups they choose to acquire.
BEST PRACTICES
Helping Parties to Mergers Assess Risk and Negotiate Smarter Deals
In order to better assess risk and negotiate smarter deals when buying or selling a private company, parties should ask: what really happens after closing? Until recently, that has been somewhat of a mystery. Even experienced deal professionals didn't have much information on what to expect, how often claims are brought, or how this impacts expected payouts. The 2011 SRS M&A Post-Closing Claims Study, a new study published by SRS, helps answer these questions.
 The good news for sellers is that an average of 86% of the consideration set aside in escrow is eventually returned to them. The bad news is that 56% of deals receive some type of claim against the escrow, and in those deals claims were made against an average of 51% of the escrow. Both sides need to be prepared to potentially expend time and resources after closing. According to the study, indemnification claims take an average of eight months to resolve, and 4% of the deals with claims went to litigation or arbitration.
Here are some examples of statistics dealmakers should consider based on data presented in the study:
1. Net working capital adjustments are very common when a deal has an adjustment mechanism (62% of the time an adjustment is made). These can favor either the buyer (61% of the time) or the seller (39% of the time). Further, when a buyer claims a negative adjustment, these are often not just minor shore-ups as sellers might expect (the average claim size represents about 15% of the escrow). Both sides should consider this risk when they value the deal. Also, the agreements should be clear as to the definition of working capital (or similar metric), and whether adjustments are to be prepared consistent with the selling company's past practices.
2. Financial statements claims are among the most frequent claim type, and they tend to be relatively large (they average 32% of the escrow) but are often made in smaller deals (less than $100M). Even for small companies, it may be worth the cost to have their financials audited, which can help avert issues regarding whether reporting was in accordance with GAAP. Additionally, this may help avoid claims asserting damages related to the inaccuracy of reported numbers that impacted a valuation based on a multiple of revenue or EBITDA.
3. Payouts on claims were reduced by indemnification "baskets" only 5% of the time. These baskets may, however, have prevented small claims from ever having been submitted. Additionally, deals with first dollar baskets received on average approximately twice as many claims as deals with deductible baskets, presumably because buyers had an incentive to bring additional claims to get over the threshold amount of the basket.
4. Most deals (72%) established an expense fund in connection with the transaction. An expense fund is a separate fund set aside by the selling stockholders to fund expenses that may arise following closing, such as legal or accounting bills. A portion of these expense funds was used in 2/3s of the transactions, but the average amount used was only 8%.
5. Of the expired escrow periods surveyed in the study, about a third of the escrows were released late due to claims, with the average delay being nine months after the end of the escrow period. Often, this is the case because the claim itself was submitted late (1/4 of transactions had claims in the last week of the escrow period). Selling shareholders should anticipate such possible delays for cash flow planning purposes.
The summary of this study is available on the SRS website. The full study is only available to SRS clients and business partners.
LIFE SCIENCES FOCUS
From Partner to Buyer - Different Model, Same Challenge
For life science startups, the ability to manage relationships with larger partners has always been a key factor in their success. From medical devices to revolutionary drugs, development cycles can be long, complex and expensive. Startups often look to venture capital to fund the earliest stages of development and testing. Once they show promise, they can attract the attention of large, public pharmaceutical, biotechnology and medical device companies to help in the later development stages and ultimately bring the product to market. Executives at life science startups manage those alliances actively, or bad things tend to happen. But what happens when instead of signing a collaborative alliance, the startup is acquired?
 Not so long ago, a typical life science startup would form a key strategic alliance with a larger partner, go public and expect that value (and float) would grow in the public equity markets. More recently, public markets have become less receptive to pre-commercial life science companies. At the same time, the venture investment model often precludes venture capital funding of these companies through the expensive later stages of development. So today many venture-backed life science companies look to acquisition as the most attractive exit option. That solves the ongoing funding problem, but the asset is still a risky, development-stage project that buyers will usually only acquire with risk-mitigating strings attached.
For this reason, buyers and sellers often establish earnout structures where certain milestones, such as regulatory approval and sales objectives, determine the ultimate payout to the shareholders. In fact, more than 80% of medical device and biotech M&A exits handled by SRS are subject to earnouts. Moreover, the amounts at stake in these earnouts are typically in the hundreds of millions of dollars, often exceeding the initial payment upon acquisition. These earnouts effectively replace the revenue sharing agreement that would have been in place had the companies entered into a collaboration agreement rather than a merger.
On its face, this seems like a great way for buyers and sellers to achieve common goals. Buyers mitigate acquisition risk, and sellers get their capital back (usually with some initial return) and get relieved of future funding responsibilities. A crucial difference between a merger and a collaboration agreement, however, is that the selling shareholders may no longer have a company and a management team to advocate for the program inside the larger corporation.
In some cases, the management team of the seller may join the buyer and continue to drive the development with the support that they need. In other cases, the management team may move on to other projects or new companies. Regardless, selling shareholders seeking the earnout payments may not have the level of the information and influence they were accustomed to receiving with an independent company and management team working in a corporate alliance.
In the end, investors face many of the same challenges they always did--they must successfully navigate the internal relationships, politics, and various strategic motivations of their large company partner to get their product approved and to market. Once their startup is acquired, however, the mechanisms, tactics, and people necessary to do so change.
Successful relationship management in a merger begins with selection of the acquirer. Savvy investors may favor an acquirer that has a genuine interest in retaining key members of seller's management that are likely to have ongoing professional and financial interests in seeing the acquired programs succeed. Then, in negotiating the earnout terms, it is advisable to select M&A counsel with attorneys who have expertise in negotiating milestone provisions of mergers or corporate partnering agreements. Finally, investors should make sure that the shareholder representative they select has the mission, time, resources and expertise to manage effectively the ongoing relationship with the acquirer.
Don Morrissey has joined SRS as an executive director and head of the life sciences practice. Morrissey brings over 15 years of leadership experience in the life sciences sector, including serving as SVP of Corporate Development and General Counsel at Replidyne and VP of Legal Affairs and Business Development at Caliper Life Sciences.
INDUSTRY INTEREST
When and Where Buyers Acquire May Hinge on a Tax Holiday
Much has been written in the media about the issue of a proposed tax holiday in the U.S. to encourage corporations to repatriate offshore earnings. Earlier this month, Reuters surveyed dealmakers and found that they favor the U.S. tax holiday on repatriation of overseas cash because it "could boost merger and acquisitions activity among U.S. industrial giants, by providing the ammunition for multinationals to go after bigger targets." Regardless of whether you believe the proposed holiday will significantly impact the M&A market overall, you may want to consider the fact that it could tip the scales in favor of acquisitions of domestic targets.
 When analysts predicted an uptick in corporate M&A activity in 2010, many noted that strong balance sheets and substantial cash reserves would enable corporate buyers to pursue strategic acquisitions. As predicted, M&A activity did pick up in 2010, rebounding from the '08/'09 downturn, and the market seems to be keeping pace thus far in 2011. Venture-backed M&A, however, still lags 2007 numbers. According to Dow Jones VentureSource, 532 acquisitions for an aggregate of $61.6 billion closed in 2007, compared to 468 for $49.9B in 2010.
As the adage of venture-backed exits goes, companies are bought, not sold. So what drives when and where buyers spend their cash reserves on M&A? While sellers cannot control or predict buyer behavior, they can educate themselves on some of the issues that may come into play when an acquirer considers its options. For example, if a U.S. startup has a good product and an impressive team that is comparable to a foreign competitor, then, all else remaining equal, the buyer will likely consider such factors as where it has available cash reserves, and what the tax implications are if it needs to move those reserves for an acquisition.
For many multinational corporations, profits have been rising--and accumulating--offshore. The Wall Street Journal and Fortune have both reported that major U.S. corporations have more than $1 trillion in profits from foreign earnings that are parked overseas to avoid U.S. taxes (though not all in cash).
Corporations that are serial buyers of venture-backed companies, including the likes of Apple, Cisco, Oracle and Pfizer, have recently begun lobbying for a corporate tax holiday, so they can bring some of their offshore earnings back to the U.S. The tax holiday proposed by Apple et al. seeks to reduce the 35% repatriation tax to about 5%. If successful, this could have a positive impact on the U.S. economy generally (though many, including the U.S. Treasury, have their doubts), and would likely be advantageous for U.S. entrepreneurs, venture capitalists and their limited partners, whom all rely largely on M&A for liquidity.
In contrast, it also stands to reason that U.S. companies looking to grow through acquisition may look abroad for targets in the absence of a tax holiday. This may be good news for non-US investors and their US counterparts who have recently put an increased emphasis on investing globally to take advantage of the exploding number of opportunities in China and India, among other countries. Israel, for example, has emerged as a hub of innovation with a wealth of high tech startups that buyers may increasingly tap for acquisition in lieu of their Silicon Valley counterparts.
Ultimately, buyers, sellers, and everyone else with a stake in the health of the M&A market in the U.S. and abroad should keep their eye on the likelihood of a repatriation tax holiday. It may just determine which companies get acquired and when.
|
Just Released
2011 SRS M&A Post-Closing Claims Study
SRS has just released this first-of-its kind study to lift the curtain on what happens after closing.
Download the summary.
Recent Transactions
In the News
4.21.11 | peHUB
SRS Expands to Help Clients Maximize Returns on Life Sciences M&A Deals
Read Article
4.12.11 | San Francisco Business Times
Shareholder Representative Services opens office in Israel
Read Article
4.4.11 | peHUB
You Sold Your Company! Too Bad It May Take Another 8 Months to Close
Read Article
About SRS
SRS | Shareholder Representative Services is the leading global expert in professionally managing the post-closing process to safeguard selling shareholders' interests in private company M&A transactions. On deals valued in aggregate in excess of $16 billion, SRS has represented more than 400 venture capital and private equity firms and over 19,000 shareholders in 44 countries. We have more knowledge and experience in serving as a shareholder representative than anyone else.
For more information visit www.shareholderrep.com
Contact Us
SRS | Shareholder Representative Services
415.367.9400 San Francisco
303.648.4085 Denver
972.54.4566013 Israel
info@shareholderrep.com
www.shareholderrep.com
|
