Despite a recent slowdown in global M&A activity, the private M&A market in both the US and the UK remains intensely competitive due to an abundance of available capital. As a consequence, and in order to present potential sellers with propositions as competitive as possible, it is imperative for buyers to be able to offer both the ability to “sprint” to a deal and expertise with key transaction deal terms that are customary in the target’s local jurisdiction. In this article, we will outline some of the salient differences in the typical US and UK M&A deal terms and highlight key factors to be aware of in order to negotiate and execute transactions in the UK in an expeditious and informed manner.
1. Purchase Price Adjustment Mechanics
A purchase price adjustment or “closing accounts” mechanism — whereby the purchase price paid at closing is derived from pre-closing estimates (typically of cash, debt, working capital, and sell-side transaction expenses) and then trued up on a post-closing basis with an independent-accountant dispute resolution mechanism — is the standard practice in the US. In the UK (and many other European jurisdictions), the preferred approach is the “locked box” adjustment mechanism. In such a structure, the parties agree to a purchase price reflective of a specified balance sheet (typically audited, but in any event, viewed as reasonably certain and not subject to dispute) as of a particular historical date, after which the economic ownership and accompanying risk of the target’s business is effectively borne by the buyer. While the locked-box structure is standard practice in the UK, it can also be used in US deals where the seller places a particular premium on purchase-price certainty or the parties cannot agree on an approach to net working capital adjustment. For example, in our proprietary deal-terms database, approximately 3% of the US deals in the period from January 1, 2020, to date in the $500 million to $1 billion deal size category used the locked-box mechanism.
In the period between the locked-box date and the closing, particular focus should be placed on the concepts of “leakage” and “permitted leakage” that outline the distributions or payments that may be made out of the business during such time. Another key economic point to consider regarding this interim period is whether the seller will be entitled to interest on the target’s cash accrual or a fixed daily ticking fee following the locked-box date.
2. Purchase Price Retention — Holdbacks and Escrows
While it is fairly common in US transactions for the seller to agree to an escrow and/or holdback as a source of recovery for the buyer against negative purchase price adjustments and/or indemnification claims, it is uncommon for sellers in the UK to agree to such a construct, absent any specifically identified issues. In lieu of any escrow or holdback, buyers are required to rely solely on direct recourse against the seller.
3. Due Diligence
In the US, a customary purchase agreement will contain a broad set of representations and warranties, and the burden is on the seller to identify potential diligence issues and list them as exceptions to the representations on the disclosure schedules. In the UK, the entire data room is essentially disclosed (to the extent that liabilities could be fairly or reasonably identified in the data room), and it is up to the buyer to identify and address potential diligence issues.
4. Representations and Warranties
A standard feature of US transactions is that generally all of the representations and warranties are provided on an indemnity basis. In the UK (and many other European markets), indemnities are provided only for specific and identified risks, and the remedy for a breach of warranties is a simple contractual claim for damages. Unlike in the US, where it would be common for representations to be given as of signing and as of closing, only the more fundamental warranties are generally made as of closing in the UK and Europe.
Representation and warranty insurance is common in both the US and the UK; however, there are some key differences. In particular, policies in the US are generally more comprehensive and contain fewer exclusions compared to policies in the UK (which is somewhat, but not entirely, offset by the availability of “knowledge scrape” in UK policies, which is not yet available in the US). As a result, policies are generally considerably cheaper in the UK relative to the premiums of 3.5% to 4.5% typically seen in the US.
5. Non-Competition Covenants
While there is significant variance across state jurisdictions in the US, there is generally a wide legal scope to determine the parameters of non-competition covenants, especially with respect to transaction-based non-competition covenants. In contrast, non-competition covenants in the UK are generally limited to two years in duration. The scope and geographic territories are also more tightly defined.
6. Buyer’s Knowledge
Absent the inclusion of any specific provision (i.e., any pro- or anti-sandbagging provision), Delaware courts will rule that a buyer’s prior knowledge of an indemnity breach will not preclude such buyer from making an indemnity claim. However, the English courts are unlikely to grant damages to a buyer for a breach of warranty claim if such buyer had prior knowledge of the breach. It is also common in the UK transactions for the purchase agreement to include anti-sandbagging language, while it is common practice for US purchase agreements to be silent on the issue.
While there are many common characteristics in the US and UK transaction structures, it is important to be cognizant of some of the salient differences. Being aware of such differences and having experience and expertise in navigating these potential issues will provide buyers with a competitive edge when exploring potential transactions in the UK market.
Pavel A. ShaitanoffPartner