Cath Shirley-Brown is a partner and co-leads Simpson Grierson’s Wellington corporate and commercial team. Cath provides advice on public and private M&A, joint venture and shareholder arrangements and corporate and commercial law generally. She assisted in the authorship of Practical Law New Zealand’s suite of share acquisitions: private documents and is currently collaborating with Practical Law New Zealand on a new practice note on warranty and indemnity insurance.
Abigail Milburn, who is heading up the launch of the Practical Law New Zealand Resource Centre, spoke to Cath about the launch of Practical Law New Zealand and asked her for her views on private M&A trends in New Zealand in 2019.
Having recently returned from a lengthy period practising M&A law in London, Cath has used Practical Law UK as a resource frequently.
“It is great to see Practical Law being launched in the New Zealand market” she said.
“We continue to have a robust market for private M&A in New Zealand, in terms of both domestic and off-shore buyers. With high levels of “dry powder” in terms of private capital, and global trade buyers seeking to expand into new markets, our general outlook is one of cautious optimism”.
Warranty and indemnity insurance
“A key trend that we are seeing on deals is the use of warranty and indemnity insurance (W&I). This product is already extremely popular in the UK and US markets, and is becoming increasingly prevalent here. W&I allows vendors to make a clean exit without a tail of contingent liability or any retained funds, while providing the buyer with meaningful recourse against a financially rated insurer. In circumstances where management are retaining an equity interest post-sale, W&I avoids the awkward situation of having to claim damages against a fellow shareholder” said Cath.
“We are finding that using W&I can ease the course of negotiations not just where the seller is a financial sponsor, but also where the business is owned by one or more founders or a family group (where the potential issue of personal recourse is particularly acute)”.
Drawing on her experience, Cath also mentioned that in the context of the New Zealand market, care needs to be taken to ensure that parties don’t see W&I as an all-purpose solution:
“A buyer looking to rely on W&I cannot use it as a substitute for conducting proper due diligence on the target business. Underwriters will require robust legal, financial and tax due diligence (and potentially other commercial or specialist due diligence) as a pre-condition to cover. Further, they will expect to see evidence that the warranty package in the sale and purchase agreement has been negotiated, and that the vendor has undertaken a comprehensive disclosure exercise” she added.
“Practitioners also need to make it clear to their clients at the outset that W&I does not provide blanket risk coverage. It’s important that clients are made aware of policy exclusions – obviously, known issues are excluded from basic cover, and there are a number of industry standard exclusions (for example, cyber security risks, environmental pollution, transfer pricing, secondary tax liability and criminal penalties and fines). In addition, it is customary to have transaction-specific carve-outs, depending on the nature of the target business, industry norm or gaps in due diligence” said Cath.
Cath concluded: “In short, W&I is a great tool for bridging the gap in terms of seller and buyer concerns around risk allocation – however, from the perspective of a legal adviser, it’s vital to ensure that the relevant parties are aware of its limitations and that the broader transaction team is mindful from the outset about the implications of its use and the intricacies of the underwriting process”.
Locked box versus completion accounts deals
“Another key trend we are seeing is an increase in the number of “locked” box deals – that is, where the equity value of a transaction is agreed up-front and supported by contractual covenants precluding value leakage to selling shareholders” Cath noted.
“This structure requires extensive up-front tax and accounting due diligence by the purchaser and is generally only an attractive option buy-side where the underlying balance sheet has been audited within a reasonably recent timeframe. However, there are distinct advantages for both seller and purchaser in terms of certainty of price and reducing the complexity of the sale and purchase agreement”.
Cath further commented that for these reasons, the locked box structure has become very common in the UK and Europe. She expects to see an increase in these deals in New Zealand and (as clients and practitioners become more familiar with the structure) a willingness to embrace different permutations.
“By way of example, I have seen deals being conducted on both a pro-forma balance sheet (where the relevant assets are being carved out of an existing corporate structure) or (where there is high confidence in managerial culture and financial discipline) on a relatively “old” balance sheet. The latter is particularly relevant in the New Zealand context, where (due to Overseas Investment Office consent requirements) there is often a lengthy period between signing and closing for offshore buyers” said Cath.
Private equity investment
Cath also commented that “New Zealand has a very healthy domestic market in terms of private capital, as is evidenced by our numerous high-performing private equity firms. With the costs of debt funding remaining relatively cheap, and both local and offshore private equity funds having high levels of “dry powder” in terms of committed and uncalled capital, we expect to continue to see private equity investment as a key mechanism for liquidity for local business owners (as well as an existing option for existing private equity owners)”.
Outlook for 2020
Cath expects the trends in M&A identified in this article to continue into 2020. ” We continue to experience domestic and off-shore appetite for New Zealand investment (from both trade and financial buyers). While we are far from the heady days of the mid-noughties in terms of very vendor-friendly sale processes, we are seeing seller-led sale processes being well-subscribed. In this context, we expect to see traditionally seller-friendly models such as W&I insurance and locked box deals on the increase” she concluded.
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