According to the fact that PE firms pushed

According to data published by PitchBook, M&A activity in
North America through the third quarter of 2017 totaled $925.3 billion across
7,348 transactions, trailing the first three quarters of 2016 by 24.3% and
22.6% respectively.  The slowdown may
have been due to the adoption of a “wait-and-see” approach by many investors awaiting
clarity on tax and healthcare reform. 

 

We believe the passage of the new tax bill on December 22, 2017 is
one of a number of factors that point to healthy M&A activity in 2018.  The tax bill should spur activity through lower
corporate tax rates, which will provide increased capital for acquisitions in
addition to the already record-levels of cash on corporate balance sheets (approximately
$2 trillion). We also see significant private equity capital to put to work as
buyout funds have over $560 billion of dry powder. Finally, interest rates remain
at historic lows. Leverage levels in private equity buyout transactions reached
peak levels (5.8x debt/EBITDA for middle-market buyouts) in 2017.

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Given
the heightened valuations and leverage in the market, conditions are
particularly good for sellers and challenging for buyers. According to
PitchBook, transaction EV/EBITDA multiples averaged 12.1x through 3Q 2017,
their highest levels in the last decade. The median EV/EBITDA for transactions
recorded in 4Q 2017 dipped to 6.3x, reflecting a sharp decrease, but according
to PitchBook this could be attributed to a change in the survey population or due
to the fact that PE firms pushed to complete deals by year-end before the
changes to US tax policy went into effect. IT, Healthcare and FinTech remain
very active sectors.

 

Deal terms include more reps and warranties and firms are looking
for greater protections. Most financial buyers and now many strategic buyers
are requiring representations and warranties insurance policies (“RWI”) as a
means to manage risk and to help facilitate a deal. According to the McDermott
Will&Emery 2017 M&A Bid Sweeteners Survey, which includes data from
over 100 deal makers, investment bankers and other M&A professionals,
almost 90% of respondent considered the offer to purchase RWI as persuasive
(42%) or very persuasive (47%).  The ABA
Private Target Mergers & Acquisitions Deal Points Study (including
transactions from 2016 and 2017) (the “Study”)
shows RWI  was present in over 29% of
deals, with the cost typically borne solely by the buyer (45%) or split by the
buyer and seller (43%) with the seller covering the sole costs in only 8% of
deals.

 

The Study offers an 18-month analysis of acquisitions of privately-held
targets by publicly-held buyers drawing from 139 middle market transactions
executed or closed between January 2016 and June 2017, ranging from $30 to $500
million in size with an average transaction value of $176.3 million. We have
prepared a summary of selected data from the Study.  In addition to the rise of the use of RWI, the
Study highlights a few additional trends in comparison to the prior ABA study:

–         
Average size of indemnification caps continue to decline, which is
likely due in part to RWI. The average cap for deals without RWI was 14.70%
versus an average of 5.77% for deals with RWI.

–         
The trend towards deductible (70%) versus first dollar baskets
continues (26%).

–         
The use of a separate purchase price adjustment escrow apart from
any indemnification escrow rose by 20% from the prior study to use in 45% of
deals.

–         
Complexity of the purchase price adjustment also appears to be on
the rise with 73% of all deals including a purchase price adjustment based on
multiple metrics, an increase of 20%.

Certain terms are
becoming almost universal with 95% of all indemnification baskets equal to or
less than 1% of transaction value and 90% of all survival periods for
representations and warranties at 18 months or less for non-fundamental representations
and warranties

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