An active deal environment is a vital ingredient for a vibrant economy and an essential growth driver for many businesses. At the heart of every acquisition of an unlisted entity is a Sale and Purchase Agreement (SPA) that defines both the terms of the transaction and the basis for deriving the final purchase consideration.
The final price or ‘equity value’ paid for a business is often substantially different from the headline offer or ‘enterprise value’ initially agreed. Completion mechanisms which give rise to price adjustments can also be complex and subjective.
Therefore, to provide practitioners with insight to enable them to make better informed decisions when next having to negotiate the equity value adjustments and the SPA, Grant Thornton UK spoke to buyers, sellers and advisers to define what constitutes market practice. The highlights are shared in this article.
Identifying market practice for equity value adjustments
Our research, conducted in partnership with consultancy Meridian West, draws on the collective experience of over 150 deal experts, who between them have conducted thousands of deals.
- How should certain value adjusting items be treated?
- What kind of pricing mechanism should be used?
- On which areas of the deal negotiation should management focus their time and attention?
- What are the common areas of disagreement and dispute post deal and how can these be avoided?
While the answers vary according to the specifics of the deal, the weight of these questions is not academic and often has a significant real value impact on the deal. Often, up to 10% of the price is contested because of disagreement about what constitutes market practice.
Our research reveals a number of findings, including:
- Locked boxes are becoming increasingly popular, with nearly three quarters of respondents reporting that the use of locked box mechanisms has increased over the past 5 years to almost 50% of deals
- Deferred income, normalised working capital, treatment and definition of cash are some of the most highly contentious value items discussed in deal negotiations
- Completion account mechanisms, despite being a highly-negotiated area, lead to more disputes than locked box mechanisms
- Earn outs are prevalent and becoming more common.
Our research also indicated that there is consensus in the market that a lack of identifiable market practice slows down deals and may lead to unnecessarily protracted negotiations and even costly or preventable disputes post-completion. There is clearly a significant appetite for greater harmonisation and standardisation in completion mechanisms and how SPAs are compiled.
We believe there is a smarter way to get deals done, in which both parties take fair and equitable starting positions that will see the interests of all protected. This smarter way enables advisers and management to concentrate their efforts on resolving the genuine commercial issues and avoiding disagreement on process-type issues, and hence closing deals faster and more amicably.
While the majority of respondents are UK-based, many also have experience in doing deals across borders. Client feedback from the 2016 survey highlighted considerable interest in understanding the international trends in this field. In response to that, for 2017 we are planning an international survey to address the market need.
A roadmap for smarter SPAs
As parties and transactions become increasingly sophisticated and complex, the benefits of specialist SPA teams advising clients on the completion mechanism and SPA are being acknowledged.
Our team combines completion mechanism adjustment and dispute specialists to help principals and advisers reach an agreement on the SPA that protects real value, whilst reducing the risk of disputes or resolving them.