M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Sunday, December 9, 2007

The Future of Private Equity M&A

Last week, I posted the Wounded and the Dead, discussing the abnormally high number of deals in today's M&A market which are either dead or walking wounded.  But, as a bright market observer pointed out to me, even the majority of private equity deals, over thirty of them in fact, have completed during this time of extreme market turbulence.  And some of them, such as Coinmach Service/Babcock and Catalina Marketing/Hellman & Friedman Capital, could also have been classified as walking wounded prior to their close.  So, for those who make their money on these deals -- sponsors, investment banks, lawyers and even arbitrageurs -- it is not time to retire or otherwise go into a new business (NB. academia is great). We can learn from deals that have succeeded during this time to structure more certain transactions. So, here are my thoughts on the dos and don'ts for future private equity deals -- some are short-term recommendations based on current economic and market conditions; others more lasting.  And obviously, they are aspirational and may bend to commercial realities. At the end of the list, I put forth a non-exclusive list of the thirty or so private equity deals which have closed with some notes. 

The Do's and Don'ts of Private Equity

The Basics

  1. Don't Sign Options, sign deals.      
  2. Be in the right business.  Don't be in the mortgage lending business (AHL, Fremont, Option One, MGIC/Radian); Don't be tied into housing in any way or in retail or service businesses that subsidize sales with credit to customers without more general access to credit.  Be careful generally if you are in a cyclical retail industry.  This may change, but right now the credit markets are too unstable to finance these types of deals on a certain basis. 
  3. Keep Things Simple.  Don't deal with equity syndicates, consortiums, multiple sponsors and the like (SLM, etc.)--no closings contingent on other closings (PHH).
  4. Restructuring an agreed deal is not necessarily a good thing.  Don't allow a sponsor to reduce equity exposure pre-closing (Home Depot); Don't leave financing as a post-announcement condition (CKX).
  5. Know thyself.  Don't blow your quarterly numbers; Especially, don't blow your covenants (Harman).  Fire your CFO if the latter happens.  Small consolation but a necessity.  EBITDA conditions are actually that. 
  6. Reputation matters.  Work with established private equity firms with lots of clout. They have been in this business for years and will need to be there in the coming ones.  This is not the time to work with new entities no matter how good their principals are.  Here, I believe Blackstone and Fortress being public actually make them less likely to try to walk on deals because of their increased public profile.  Note this KKR. 
  7. Reputation goes both ways.  Don't lie or stretch the truth too much prior to executing a contract. It may not be fraud; but it is not nice and it pisses people off (GCO, maybe).
  8. Avoid Hedge Fund deals.  Hedge funds have less reputational capital at stake.  They are in these deals to seek alpha and will change style and go back to trading oil if the playing field suddenly changes. 
  9. Leverage Stapled-Financing.  Pick your banks carefully -- use staple-financing negotiations to firm up your financing letters and provide flexibility to restructure deals if you so agree. 
  10. Get Good Lawyers.  Retain experienced M&A counsel.  Think hard about retaining counsel which has such sell-side experience but does not regularly represent private equity firms (the excellent M&A lawyers at Shearman & Sterling and Wachtell, despite their difficulties, spring to mind).  Do not retain Wilson Sonsini (3Com, Acxiom).   

  11. Get an independent Financial Advisor.  Think hard about hiring an independent M&A bank (Greenhill, Perella have some terrific people).  It is increasingly clear that the majors lack internal leverage with their own financing departments. If things get difficult -- don't expect them to be there for you or otherwise ignore the conflict. 

  12. Remember.  Do not do a deal with Cerberus; do not do a deal financed by UBS.  Remember, even Goldman Sachs via GS Capital Partners invoked a MAC and a breach in Harman.   Ask your lawyers specifically about closing risks -- point them to the Avaya deal as a good example of a specific performance clause.  See the trading prices of Acxiom, Harman, URI, etc. to remind you of the effects of a cratered deal in light of reverse termination fees and heightened optionality.  Note the shareholder lawsuits in their wake. 

The Lawyers

  1. Do not negotiate options, negotiate deals.  Look at the Avaya model as precedent -- negotiate specific performance of the financing letters. Strongly advise your clients of the commercial risks if they do agree to a pure reverse termination fee. Negotiate higher reverse termination fees if you do have to make such a deal.
  2. Two-tiered termination fees mean nothing.  The recent trend (3Com, etc.) is to have a two-tiered termination fee -- the lower if financing is unavailable, the higher for a pure breach.  Realize that in a renegotiation, the private equity firm is always going to have a strong case for the lower one and that it is the starting point and settlement will only be lower (Acxiom).  It is highly unlikely that the fee will ever go much above the lower one.  A two-tiered break up fee is a cosmetic.   
  3. A MAC Clause is nothing but a negotiating tool in the hands of the willing.  Remember this.
  4. Avoid complex drafting.  If any section of your agreement has one or more "to the extent applicables", "Notwithstanding", or otherwise has too many caveats redraft it to make it clearer and unambiguous.  Stay awake the extra two hours to do this. 
  5. Choice of Forum clauses matter.  Don't give your buyer leverage for settlement and postponement by being able to litigate in multiple jurisdictions (Genesco, URI).  Delaware is again proving themselves in these disputes as the place to litigate. 
  6. Choice of Law clauses matter.  N.Y. is the law for financing documents.  Delaware is generally the law for merger agreements.  Neither is likely to change.  Find a work-around that deals with this disparity.
  7. Do not boilerplate deals.  For example, Wilson Sonsini using the same structure for 3Com the week a similar structure they used in Acxiom cratered.  Market forces require a rethink of how these documents work -- don't simply use the olds ones.
  8. Financing Documents matter.  Think about third party beneficiary clauses in equity commitment and financing letters (URI). 
  9. Guarantees matter.  If you have a specific performance model make it clear the guarantee is unaffected.  Read these letter thoroughly and make sure they interact correctly with the merger agreement. 
  10. Think three steps ahead.  Spend an hour talking through scenarios in light of what happens.  For example, these disputes inevitably span shareholder litigation -- have MAC and rep carve-outs for such eventualities (if possible). 


  1. Go-shops are ephemeral.  Go-shops have seldom turned up competing bids.  Management and the private equity buyer have too much of a head start.  And when they do come in (Restoration Hardware, Topps), management is still likely to attempt to manipulate the process towards their favored pe firm. 
  2. If it is seems shaky, it is. If, upon deal announcement, the analysts think it is over-leveraged, it likely is.
  3. Avoid deals where management is too cute on their disclosure.  For example, putting closing conditions in a schedule and then not disclosing what they are (3Com); not disclosing a possible renegotiation (URI), etc.  This not only is a possible violation of the federal securities laws, it is a trap for the unwary (of course, in some cases we won't know this until it happens).
  4. Nothing is Certain.  Leave this type of investing to the professionals. 

Here is a non-exclusive list of private equity deals which have closed since August.  Read them, study them, learn. 

  • 1-800 Contacts/Fenway Partners closed September 6. 2007.  Per the merger agreement, reverse termination fee of $10,330,550 rising to $13,774, 000 if there is a willful breach by Fenway with Fenway guaranteeing; language appears to permit specific performance if no termination.
  • Aeroflex/Vertitas Capital closed in August--Per the merger agreement, $20,000,000 reverse termination fee; specific performance clause nullified. 
  • Alltel/GS Capital Ptners/TPG Capital closes late November despite market jitters.  Per the merger agreement, $625,000,000 reverse termination fee. 
  • Applebees/IHOP closes late November despite jitters over whether financing would fall through --Per the merger agreement, deal had specific performance with no outs for IHOP.
  • Archstone-Smith/Lehman Bros Tishman Speyer closes in early October -- Per the merger agreement, very large $1.5 billion reverse term fee but no specific performance (25% of Lehman's equity commitment and 100% of Tishman Speyer's),
  • Avaya/Silverlake-TPG Capital closes in October -- a very good merger agreement with specific performance of the debt and equity financing required (similar to Affiliated Data Services).  Every M&A attorney should read this agreement.   
  • Bausch & Lomb/Warburg Pincus closes late October--merger agreement states Bausch & Lomb cannot seek specific performance and its reverse termination fee of $120mm is sole exclusive remedy.  I was surprised B&L was so accommodating in a competitive situation. 
  • BISYS/Citigroup and J.C. Flowers closed early August -- merger agreement provided for $36 million reverse termination fee as sole and exclusive remedy for BISYS. 
  • Catalina Marketing/Hellman & Friedman Capital partners closed early October -- a walking wounded deal -- per the merger agreement, a $50,640,000 reverse termination fee with specific performance excluded.
  • CDW Corp/Madison Dearborn Partners-Providence Equity Partners closed mid Oct -- per the merger agreement, a $146,000,000 reverse termination fee with $292,000,000 cap on damages -- no right of specific performance.
  • Ceridan/Thomas H. Lee and Fidelity National Financial closed in early November; per the merger agreement, Cerdian had right to enforce specific performance. A $165,000,000 reverse termination fee.
  • Coinmach Service/Babcock and Brown Infrastructure--closed in late November; a walking wounded deal; per the merger agreement, a $15,000,000 million reverse termination fee (small); oddly no specific performance clause at all; equity was syndicated; weak sponsor; closing delayed day by day waiting for equity to show up (I guess).
  • Crescent Real Estate Equities/Morgan Stanley Real Estate closes in August -- per the merger agreement, $300 million reverse termination fee -- no specific performance. 
  • Deb Shops/Lee Equity Partners closed late October -- per the merger agreement, $15,000,000 reverse termination fee; no specific performance clause.
  • Equity Inns/Whitehall Street Global Real Estate Limited Partnership closed late October -- per the merger agreement, a $75,000,000 reverse termination fee. Odd tax language concerning treatment of such payment (may be useful?).  Good limitation language on specific performance. 
  • First Data/KKR closes late September -- walking wounded deal -- per the merger agreement, $700 million reverse termination fee; specific performance excluded; much clearer agreement than URI; negotiated by Simpson for KKR.
  • Friendly Ice Cream/Sun Capital Partners closed late August -- per the merger agreement, a low $5,000,000 reverse termination fee; ambiguous on specific performance. I love Reeses Pieces sundaes. 
  • Guitar Center/Bain Capital closed early Oct; a walking wounded deal -- per the merger agreement, a $58,000,000 reverse termination fee with a higher damages cap of $100,000,000.  Another ambiguous agreement as to whether specific performance is available. 
  • John Nuveen/Madison Dearborn Partners closed mid November -- per the merger agreement, $200,000,000 reverse termination fee doubling to $400,000,000 under certain conditions; no specific performance.
  • MC Shipping/ Bear Stearns Merchant Banking Partners closed mid Sept; per the merger agreement, a plain vanilla deal with a standard specific performance clause (if you count a merger under Liberian law plain vanilla).
  • National Home Health Care/Angelo Gordon finally closes late November; drop-dead date extended due to issues obtaining regulatory approvals and EBDITDA condition of merger agreement; per the merger agreement, the deal was conditioned on financing and there was no reverse termination fee.
  • Ryerson/Platinum Equity closed mid October -- per the merger agreement, $25,000,000 reverse termination fee -- no specific performance clause. 
  • Sequa/Carlyle closed last week -- per the merger agreement, no specific performance and a $60,570,000 reverse termination fee.
  • Samsonite/CVC Cap Partner -- per the merger agreement, specific performance available -- although some ambiguity; $50,000,000 reverse termination fee; all equity financed.
  • Smith & Wollensky/Patina Restaurant Group closed in August; merger agreement had no specific performance fee or specific performance clause -- competing bidder -- companion asset sale of NYC restaurant assets to Stillman entity also closed simultaneously.
  • Smithway Motor Express/Western Express closed end of October; per the merger agreement; this had only a $1,000,000 reverse termination fee with an ambiguous specific performance fee which excludes such a remedy when the financing is unavailable; was expected to close in August and had lots of delays. Western Express represented by inexperienced private equity counsel. 
  • Station Casinos/Fertitta Colony Partners closed in November -- per the merger agreement, reverse termination fee of $160,000,000.  Good provision on this being the sole and exclusive remedy of Station Casinos. 
  • Symbion/Crestview Partners (equity partner Northwestern Mutual) closed in late August -- per the merger agreement, $12,500,000 reverse termination fee, but specific performance still available.  Not a standard agreement (looks like a sell-side merger agreement drafted by counsel which did not regularly do pe deals). 
  • Topps/Tornante closed in October -- complex -- with an intervening bid by Upper Deck.  per the merger agreement, a $12,000,000 reverse termination fee but also specific performance. 
  • TXU/KKR-TPG-GS closed in October -- per the merger agreement, $1 billion reverse termination fee -- a bit of ambiguity but likely no specific performance permitted. 
  • Vertrue/One Equity; Rho Ventures (Oak Investment dropped from the deal); Brencourt Advisors closed in mid August -- per the merger agreement ,$17,500,000 reverse termination fee with no specific performance.


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Do's and Don'ts are great when considering future deals, but what of current unclosed deals ?

A good point was made by a concerned investor on Yahoo, when he referenced a "Cerebus clause" in a merger agreement (being else-where referred to as "walk-away at will" merger agreements) ,,, to which I responded as follows :

Deal investors should assume that for every unclosed merger with a private equity firm, deal lawyers for buyers attempted to create "walk-away at will" contracts, by ensuring 'escapes' in every possible location in buyout documents

IMO, PE firms appear no longer trustworthy when it comes to merger agreement documentation, and investors are left in position of pondering unspoken buyer intentions throughout the remaining buyout processes

The mess Cerberus has created with URI will likely boomerang the entire PE buyout spectrum, particularly if Chancery rules against URI on the motion for summary judgement

,,, like post-August07 merger agreements, we'll also have to look closely at new agreements, post-CERB/URI blow-up (NOV07), where PE firms are involved, regardless of the CERB/URI outcome ,,, that is, if PE firms can find targets willing to sign-on to "walk-away at will" merger agreements, styled to the maximum benefit of involved PE's

For the ongoing crop, investors have no choice but to follow their gut feelings ,,,

Posted by: Mike | Dec 8, 2007 7:46:39 PM

Combining thoughts from your statements below, if the PHH/GE/BX deal doesn't close by 31DEC, will Blackstone have actually dinged-up its reputation by backing away from a mortgage company acquisition ?

> 2. Be in the right business ,,, Don't be in the mortgage lending business 3. Keep Things Simple ,,, no closings contingent on other closings (PHH) 6. Reputation matters ,,, I believe Blackstone ,,, being public actually make them less likely to try to walk on deals because of their increased public profile. <

Meanwhile, investors should be forgiven for confused thinking that top-tier companies General Electric and Blackstone could figure out how to be "ready, willing, and able" to finish such a small $ deal ,,,

"Ready, willing, and able to walk-away" - perhaps idea for a new clause in PE-sponsored merger agreements of the future ?

Posted by: Mike | Dec 8, 2007 8:29:04 PM

nice list. you've got the wrong link, however, for servicemaster/CDR, which did not close out of bankruptcy. bankruptcy, after all, would not be honoring god in all that they do.

Posted by: bob | Dec 10, 2007 5:14:06 PM

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