Earn Outs
Next, the study shows that fewer deals included earn outs than in the past (25% in 2012 versus 38% in 2010), reflecting more certainty in the M&A market, and 32% of those had an earn out period of 12 months (compared with 36% of deals with earn out periods of 36 months or more in 2010). For the deals with earn outs, a significant majority did not include a covenant to run the business consistent with past practice (76%) or to run the business to maximize the earn out (88%) and a similar majority of earn outs did not expressly accelerate on a change of control (76%). In addition, the majority of deals with earn outs (68% in 2012 versus 62% in 2010) expressly allowed the buyer to offset any indemnity payments against the earn out and more deals included an express disclaimer of a fiduciary relationship regarding the earn out than in prior years (15% in 2012 versus 3% in 2010).
Indemnification
The study also discusses various points relating to indemnification, some of which we highlight here.
- Baskets. Consistent with past years, the majority of deals (59%) included a deductible, where the seller is only responsible for losses exceeding the deductible, and 32% of deals included a ‘first dollar’ provision, where the seller is responsible for all losses once a certain threshold is met. In addition, a small number of deals (5%) reflected a combination of these provisions, where the seller is only responsible for losses once a threshold is met and then only for losses over a deductible amount set lower than the threshold. These baskets typically represented 0.5% or less of the deal value (56% of the deals) or between 0.5% and 1% of the deal value (32% of the deals), and included carve-outs for fraud and for representations regarding broker’s/finder’s fees, capitalization, due authority, due organization and taxes, among others. Fewer deals used baskets for breaches of covenants (27%) or other indemnity claims (18%) than in prior years, but more deals included ‘mini-baskets’ (or ‘de minimis’ baskets), i.e. a threshold for a single claim to be eligible for indemnification (30% in 2012 versus 17% in 2010).
- Caps. Reflecting a slight increase over past years, the overwhelming majority of deals with survival provisions (89%) included caps on indemnification that are less than the purchase price, and a small number (5%) had a cap equal to the purchase price. In these deals, over half (60%) had cap amounts that were 10% or less than the deal value, and 29% had cap amounts between 10% and 15% of the deal value, and included similar carve-outs as the baskets.
- Escrows and holdbacks. Similar to past years, a slight majority of deals with survival provisions (55%) had an escrow or holdback that was not the exclusive remedy, and 32% had an escrow or holdback that was the exclusive remedy (versus 24% in 2010). Slightly fewer deals had no escrow or holdback at all (11% in 2012 versus 14% in 2010). Of the deals with escrows or holdbacks, 47% reflected 7% or less of the deal value, 24% reflected more than 7% but less than 10% of deal value, and the remaining 29% reflected 10% or more of the deal value. While this generally reflects a decrease in the size of escrows and holdbacks as a percentage of the deal value compared to prior years, the median transaction value also increased, so the actual dollar amount in the escrows or holdbacks may have increased.