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A guide to the use of material adverse change clauses in M&A
This article is part of a series on Mergers and Acquisitions
A material adverse change (MAC) is one of several legal mechanisms used to reduce risk and uncertainty for buyers and sellers during the period between the date of the merger agreement and the date the deal closes. MACs are legal clauses that buyers include in virtually all merger agreements that outline conditions that might conceivably give the buyer the right to walk away from a deal. Other deal mechanisms that address the gap-period risks for buyers and sellers include as well as s. and
In our , we saw that when Microsoft acquired LinkedIn on June 13, 2016, it included a $725 million break-up fee that LinkedIn would owe Microsoft if LinkedIn changed its mind prior to the closing date.
Notice that the protection given to Microsoft via the breakup fee is one-directional — there are no breakup fees owed to LinkedIn should Microsoft walk away. That's because the risk that Microsoft will walk away is lower. Unlike LinkedIn, Microsoft doesn't need to get shareholder approval. A common source of risk for sellers in M&A, especially when the buyer is a private equity buyer, is the risk that buyer can't secure financing. Microsoft has ample cash, so securing financing isn't an issue.
That's not always the case, and sellers often protect themselves with reverse termination fees.
However, that doesn’t mean Microsoft can simply walk away for no reason. At the deal announcement, the buyer and seller both sign the merger agreement, which is a binding contract for both the buyer and seller. If the buyer walks away, the seller will sue.
So are there any circumstances in which the buyer can walk away from the deal? The answer is yes. ... kind of.
In an effort to protect themselves against unforeseen changes to the target's business during the gap period, virtually all buyers will include a clause in the merger agreement called the material adverse change (MAC) or material adverse effect (MAE). The MAC gives the buyer the right to terminate the agreement if the target experiences a material adverse change to the business.
Unfortunately, what constitutes a material adverse change is not clear cut. According to Latham & Watkins, courts litigating MAC claims focus on whether there is substantial threat to overall earnings (or EBITDA) potential relative to past performance, not projections. The threat to EBITDA is typically measured using long-term perspective (years, not months) of a reasonable buyer, and the buyer bears the burden of proof.
Unless the circumstances that trigger a MAC are very well defined, courts generally are loath to allow acquirers to back out of a deal via a MAC argument. That said, acquirers still like to include a MAC clause to improve their bargaining position with a litigation threat should problems with the target emerge post announcement.
As one might imagine, during the financial meltdown in 2007-8, many acquirers tried to back out of deals in which the targets were melting down using the MAC clause. These attempts were largely denied by courts, with Hexion’s acquisition of Huntsman being a good example. Hexion tried to back out of the deal by claiming a material adverse change. The claim didn’t hold up in court and Hexion was forced to compensate Huntsman handsomely.
MACs are heavily negotiated and are usually structured with a list of exclusions that don’t qualify as material adverse changes. Perhaps the largest difference between a buyer-friendly and seller-friendly MAC is that the seller friendly MAC will carve out a large number of detailed exceptions of events that do NOT qualify as a material adverse change.
For example, the exclusions (events that explicitly won’t count as triggering a MAC) in the LinkedIn deal (p.4-5 of the merger agreement) include:
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