Kevin Norman ( Evonik Corporation) - PowerPoint Presentation

1. Kevin Norman (Evonik Corporation) | October 17, 2016 | San FranciscoRyan Quinn (Nordson Corporation)Gary Ross (Xylem Inc.)Thomas Sauermilch (McDermott Will & Emery LLP)

2. Overview Slide 3Material Adverse Change Closing Condition Slide 4Material Adverse Effect Slide 6 Accuracy of Seller’s Representations Slide 8Indemnification (Caps, Baskets, De Minimis) Slide 13Survival / Time to Assert Claims Slide 22Materiality Scrape Slide 25Damages Limitations Slide 28Disclosures / Sandbagging Slide 33Knowledge Standards Slide 37Post-Closing Purchase Price Adjustments Slide 39Locked Box Transactions Slide 41Alternative Dispute Resolution Slide 44Termination and Reverse Termination Fees Slide 50Representations and Warranties Insurance Slide 52Sources:2015 ABA European Private Target M&A Deal Points Study (2012-2013 European deals) (“2015 European Deal Study”)2013 ABA European Private Target M&A Deal Points Study (2009-2011 European deals) (“2013 European Deal Study”)2015 ABA Private Target Mergers & Acquisitions Deal Points Study (2014 US deals) (“2015 US Deal Study”)2013 ABA Private Target Mergers & Acquisitions Deal Points Study (2012 US deals) (“2013 US Deal Study”)2016 SRS Acquiom M&A Deal Terms Study (2012-2015 deals with approximately 80% US and Canada concentration, with the rest consisting of European deals) (“2016 Deal Study”)2014 SRS Acquiom M&A Deal Terms Study (2010-2013 deals) (“2014 Deal Study”)2015 CMS European M&A Study (“CMS Study”)Houlihan Lokey 2014 Transaction Termination Fee Study Summary (“HL Study”)Practical Law Reverse Break-up Fees and Specific Performance: A Survey of Remedies for Financing and Antitrust Failure (2016 Edition) (“PLC Study”)RWI: Marsh Annual Transaction Risk Report 2015 Year in ReviewMcDermott Will & Emery LLP Review of Mergers & Acquisition Transactions Database of Thompson Reuters Business Law Center (“MWE Review”)2Table of Contents

3. MaterialityMaterial Adverse Change Closing Condition Material Adverse Effect Qualifiers Accuracy of Seller’s Representations: When and How Must They Be Accurate?Indemnification AmountsCapsBasketsDe Minimis ThresholdIndemnification TermsSurvival PeriodMateriality Scrape Damages Limitations DisclosuresSandbaggingKnowledge StandardsPost-Closing Purchase Price AdjustmentsLocked Box TransactionsAlternative Dispute ResolutionTermination and Reverse Termination Fees Representations and Warranties Insurance Q&A3Overview of Topics

4. Stand Alone MAC:“Since the date of this Agreement, there has not been any Seller Material Adverse Change.”Back-Door MAC: “Since the Balance Sheet Date, there has not been any Seller Material Adverse Change.” Plus closing condition “bringing down” the accuracy of Seller’s reps and warranties:“The representations and warranties made by Seller in this Agreement shall be true and correct in all material respects when made and at the Closing Date as if made on the Closing Date.”4Material Adverse Change (MAC) Condition

5. 5Material Adverse Change (MAC) Condition

6. Example:“‘Material Adverse Effect’ means any change…except to the extent resulting from (A) changes in general local, domestic, foreign, or international economic conditions, (B) changes affecting generally the industries or markets in which Company operates, (C) acts of war, sabotage or terrorism, military actions or the escalation thereof, (D) any changes in applicable laws or accounting rules or principles, including changes in GAAP, (E) any other action required by this Agreement, or (F) the announcement of the Transactions.”6Material Adverse Effect (MAE)

7. 7MAE Defined with Carve-Outs

8. Single point in time: at closingEach of the representations and warranties made by Seller in this Agreement shall have been accurate in all respects as of the Closing Date as if made on the Closing Date.Two points in time: at signing and closingEach of the representations and warranties made by Seller in this Agreement shall have been accurate in all respects as of the date of this Agreement, and shall be accurate in all respects as of the Closing Date as if made on the Closing Date.8Accuracy of Seller’s Representations: When Must They Be Accurate?

9. 9Accuracy of Seller’s Representations as Closing Condition: When Must They Be Accurate?*Note: The 2015 US Deal Study and 2016 Deal Study do not break out instances in which accuracy of seller’s representations is not a closing condition.

10. 10Accuracy of Seller’s Representations as Closing Condition: How Must They Be Accurate?Accurate in All Respects:Each of the representations and warranties made by the Company in this Agreement is true and accurate in all respects.Accurate in All Material Respects:Each of the representations and warrantied made by the Company in this Agreement is true and accurate in all material respects.MAE Qualification:Each of the representations and warranties made by the Company in this Agreement is true and accurate in all respects, except for inaccuracies of representations or warranties the circumstances giving rise to which, individually or in the aggregate, do not constitute and could not reasonably be expected to have a Material Adverse Effect.

11. 11Accuracy of Seller’s Representations as Closing Condition: How Must They Be Accurate?Polling Question:In cross-border transactions I have worked on, the bring-down of representations and warranties was made primarily to the following standard:Accurate in all material respectsAccurate to an MAE standardDifferent standardI do not have experience with this

12. 12Accuracy of Seller’s Representations as Closing Condition: How Must They Be Accurate?

13. 13Indemnification Caps

14. 14Indemnification Caps

15. Deductible:“Seller shall not be required to indemnify Buyer for Losses until the aggregate amount of all such Losses exceeds $500,000 (the “Deductible”) in which event Seller shall be responsible only for Losses exceeding the Deductible.”First Dollar:“Seller shall not be required to indemnify Buyer for Losses until the aggregate amount of all such Losses exceeds $500,000 (the “Threshold”) in which event Seller shall be responsible for the aggregate amount of all Losses, regardless of the Threshold.”Combination:“Seller shall not be required to indemnify Buyer for Losses until the aggregate amount of all such Losses exceeds $500,000 (the “Threshold”) in which event Seller shall be responsible only for Losses in excess of $300,000 (the “Deductible”).”15Indemnification Baskets

16. Polling Question:In my experience, indemnification baskets are typically:DeductibleFirst dollarCombination of First Dollar and DeductibleI do not have experience with this16Indemnification Baskets

17. 17Indemnification Baskets

18. 18Indemnification Baskets

19. 19Indemnification Baskets

20. Example:“Sellers shall not be required to indemnify Buyer for any individual item where the Loss relating to such claim (or a series of claims arising from the same or substantially similar facts or circumstances) is less than $_______.”20Indemnification De Minimis Threshold

21. 21Indemnification De Minimis Threshold

22. Indefinite Survival:“All representations, warranties, covenants, and obligations in this Agreement, the Disclosure Letter, the supplements to the Disclosure Letter, and any certificate, document, or other writing delivered pursuant to this Agreement will survive the Closing and the consummation and performance of the Contemplated Transactions.”Time Limitations:“If the Closing occurs, Seller shall have liability under Section 11.2(a) with respect to any Breach of a representation or warranty (other than those in Sections…, as to which a claim may be made at any time), only if on or before that date is two years after the Closing Date, Buyer notifies Seller’s representative of a claim, specifying the factual basis of the claim in reasonable detail to the extent known by Buyer.”22Survival / Time to Assert Claims

23. 23Survival / Time to Assert Claims<12 months 12 Months to 18 Months >18 Months

24. 24Survival / Time to Assert Claims

25. Materiality Qualification Disregarded for All Indemnification-Related Purposes (double scrape):“For purposes of this Article VIII (Indemnification), the representations and warranties of Target shall not be deemed qualified by any references to materiality or to Material Adverse Effect.”Materiality Qualification Disregarded for Calculation of Damages/Losses Only (single scrape):“For the sole purpose of determining Losses (and not for determining whether or not any breaches of representations or warranties have occurred), the representations and warranties of Target shall not be deemed qualified by any references to materiality or to Material Adverse Effect.”25Materiality Scrape – Two Common Variants

26. 26Materiality Scrape – Two Common VariantsPolling Question:In the deals I have worked on, a materiality scrape was most often:Not includedSingle scrapeDouble scrapeI do not have experience with this

27. 27Materiality Scrape

28. 28Damages Limitations: Types of Losses Frequently ExcludedCategories of DamagesPunitive damages: Damages that are awarded to an injured party beyond what is necessary to compensate them for their losses and are intended to punish the wrongdoing party.Incidental damages: Damages that are awarded as compensation for the buyer’s commercially reasonable expenses resulting from a breach by the seller. Consequential damages: Damages that are not a direct result of an act, but a foreseeable consequence of the initial act.Indirect damages: Often defined as consequential damages, or consequential and incidental damages. Measures of LossLost profits: Profits that the non-breaching party fails to realize because of breach.Diminution in value: Measure of value lost due to circumstances that caused the loss.Multiple-based damages: Measure of difference between multiple-based, paid purchase price based on a multiple of inaccurate financial statement items and what the purchase price would have been upon application of the multiple on accurate financial statement items.

29. Polling QuestionIn the deals I have worked on, incidental, punitive and consequential damages, lost profits, diminution in value and multiple-based damages were typically:Expressly excludedHeavily negotiatedSilentI do not have experience with this29Damages Limitations: Types of Losses Frequently Excluded

30. 30Damages Limitations

31. 31Damages Limitations

32. 32Damages LimitationsLargest disparity between the U.S. and Europe is in punitive damages.Transaction with U.S. target three times more likely to expressly exclude punitive damages than a deal with a European target.Additionally, transaction with a European target is approximately twice as likely to expressly include consequential damages.

33. Specific DisclosuresThe US tendency in stock purchase agreements is to make specific disclosures against particular warranties, set out on disclosure schedules.Fair Disclosure of Data Room ContentsIn UK and Germany, there are specific disclosures but often also disclosure of the contents of the entire data room, tempered somewhat by the concept of “fair disclosure”. Information in the data room must enable a buyer to assess, in a reasonably informed manner, the circumstances giving rise to a breach of warranty for such buyer to be deemed to have known than an item in the data room served as an exception to a warranty.33Disclosures – Specific Disclosure vs. Fair Disclosure of Data Room Contents

34. Benefit of the Bargain / Pro-Sandbagging“The right to indemnification, payment, reimbursement, or other remedy based upon any such representation, warranty, covenant, or obligation will not be affected by . . . Any investigation conducted or any knowledge acquired at any time.”Anti-Sandbagging“No party shall be liable under this Article for any Losses resulting from or relating to any inaccuracy in or breach of any representation or warranty in this Agreement if the party seeking indemnification for such Losses had Knowledge of such Breach before Closing.”34Sandbagging

35. Polling Question:In the deals I have worked on, there is normally a:Pro-sandbagging clauseAnti-sandbagging clauseSilent as to sandbaggingI do not have experience with this35Sandbagging

36. 36Sandbagging

37. Actual Knowledge:“Knowledge” means the actual knowledge of the directors and officers of Target.Constructive Knowledge (Role-Based):“Knowledge of the Target” means the actual knowledge of the Chief Executive Officer, the President and the Chief Financial Officer of Target and the knowledge that each such person would reasonably be expected to obtain in the course of diligently performing his or her duties for the Target.Constructive Knowledge (Express Investigation Requirement):“Knowledge” means the actual knowledge of the directors and officers of Target and the knowledge that each such person in his/her role as director or officer should have after due and careful inquiry.37Knowledge Standards

38. 38Knowledge Standards*Note: Constructive knowledge elements may overlap.

39. Example:“The ‘Adjustment Amount’ (which may be a positive or a negative number) will be equal to the amount determined by subtracting the Closing Working Capital from the Initial Working Capital. If the Adjustment Amount is positive, the Adjustment amount shall be paid by wire transfer by Seller to an account specified by Buyer. If the Adjustment Amount is negative, the difference between the Closing Working Capital and the Initial Working Capital shall be paid by wire transfer by Buyer to an account specified by Seller.”…“‘Working Capital’ as of a given date shall mean the amount calculated by subtracting the current liabilities of Seller…as of that date from the current assets of Seller…as of that date. The Working Capital of Seller as of the date of the Balance Sheet (the “Initial Working Capital”) was _____ dollars ($_______).”39Post-Closing Purchase Price Adjustments

40. 40Post-Closing Purchase Price Adjustments

41. Mechanism:Set effective date of relevant balance sheets prior to signing or closing.Final adjusted price is agreed between the parties and written into the purchase agreement.Seller has sole control in preparing the relevant balance sheet.No closing accounts are required.Representations and warranties, covenants and indemnification secure the buyer between locked box date and closing.Protection of leakages (including provision for no leakage and permitted leakage)Buyer diligence of books and records post-closing.Reimbursement of leakage on a one-to-one basis.Leakage claims should be carved out of any de minimis or maximum thresholds.Interest charge on the purchase price.41Locked Box Transactions

42. Pros:Price certainty.No complex closing mechanism to be negotiated.Lower post-closing costs.(For sellers) Increased control over the sale price and easier comparison of bids.Cons:Sufficient balance sheet is required.(For sellers) Potential loss of money in case interest charge is below the generated profit since locked box date.(For buyers) Potentially high purchase price resulting from business changes; purchase price negotiated early based on imperfect information; no use of closing mechanism to beat down the price.42Locked Box Transactions

43. 43Locked Box TransactionsSource: CMS Study

44. 44Dispute Resolution: Alternative Dispute Resolution (“ADR”)ADR provisions generally cover all disputes arising under the agreement, rather than those limited to specific purchase price adjustments or earnouts.Arbitration: A method of ADR whereby a dispute, with the consent of the parties, is submitted to a neutral person or group for a decision. Usually arbitration includes a full evidentiary hearing and presentations by attorneys for the parties.Mediation: A method of ADR whereby the parties attempt to negotiate a settlement with the assistance of a neutral third party. Unlike arbitration or litigation, the resulting agreement, or lack thereof, is controlled by the parties.

45. Polling Question:What type of dispute resolution clauses do you typically see in deals you work on:MediationArbitrationCourtI do not have experience with this45Dispute Resolution: Alternative Dispute Resolution (“ADR”)

46. 46Dispute Resolution: ADR

47. 47Dispute Resolution: Type of ADR Used

48. 48Dispute Resolution: Institution/Rules Governing Arbitration

49. 49Dispute Resolution: Who Pays Arbitration Expenses?

50. 50Termination Fee

51. 51Termination Fee*Source 2016 Deal Study

52. Typically a fee paid by buyer if it breaches the acquisition agreement or is unable to consummate the transaction due to lack of financing or failure to obtain antitrust approvals.Example:If (i) the conditions to Buyer’s obligations have been satisfied or duly waived, other than the Required Regulatory Approvals and any such conditions which by their nature cannot be satisfied until the Closing Date, and (ii) this Agreement is validly terminated by either party pursuant to a final non-appealable law or order restraining, enjoining or prohibiting the Transaction, then Buyer shall pay or cause to be paid to Seller a fee equal to the Reverse Termination Fee by wire transfer of same-day funds no later than five business days after such termination.52Reverse Termination Fee (RTF)

53. 53Reverse Termination Fee (RTF)*Source: PLC StudyReverse Termination Fee for Breach or Financing Failure

54. 54Reverse Termination Fee (RTF)Source: HL Study and MWE Review

55. 55Representations & Warranties Insurance (RWI)RWI can insure the buyer or seller against breaches of representations and warranties, including those related to financial statements and undisclosed liabilities.RWI is most common in mid-market deals. Buyer policy is more common than seller policy.Many sources attribute the uptick in RWI to the availability of cheaper policies.Additionally, private equity sellers can utilize RWI to make a clean exit.Corporate buyers are increasingly using RWI to create more competitive bids in an auction situation.

56. 56RWI in 2015

57. 57RWI in 2015

58. RWI reduces the need for traditional escrows because the insurer pays out in the event of a breach rather than the seller.In mid-market transactions, insurance retention is typically shared between buyer (in the form of deductible equal to 50% of the retention amount) and seller (in the form of an indemnity or escrow equal to 50% of the retention amount).Moreover, coverage is also available without an escrow. With no indemnity or escrow holdback, the premium for an RWI premium will be higher.RWI often provides a longer survival term than what a seller would be willing offer with little to no increase in premium and other advantages for a buyer (such as fewer damage limitations, materiality scrapes, reducing enforceability risk against sellers in cross-border transactions, etc.).58Correlation: RWI, Escrow Size & Premiums

59. Example: Enterprise valued at $100 millionWithout RWI: Seller nets $90 millionEscrow: 10% of purchase price in escrow for 12–18 months$10 million in escrowWith RWI at 3.5% premium: Seller nets $99.185 millionBuyer agrees to $500,000 indemnity deductibleSeller agrees to $500,000 escrow of funds for 12 monthsBuyer secures RWI with limit of $9 million for $315,000Insurer agrees to 3–6 year term59Correlation: RWI, Escrow Size & Premiums

60. RegionPrice Range(% of insurance limit)Retention Levels(% of transaction value)Local Market IssuesUS3 – 4%1 – 2%Insurers are raising pricing and requesting tougher terms on deals with nil seller recourse.UK1 – 1.5%0.5 – 1%Increasing use of nil seller recourse structures.Germany1.2 – 1.7%0.75 – 1%SPAs typically do not have a mechanism to update disclosures.Nordic Countries1.2 – 1.7%0.75 – 1%Reasonable, foreseeable indirect losses are usually covered.France1.5 – 2%1 – 2%Insurers do not like tipping structures even for real estate deals.Southern Europe1.5 – 2%1%For a seller-side policy, defense costs may be in addition to the limit (up to 25% of the limit).Central and Eastern Europe1.5 – 2.5%1 – 2%Increasing coverage of foreign language documents and review of local language diligence.Middle East2 – 3%1%No cover for fraud, anti-bribery or corruption.Australia and New Zealand1.1 – 1.4%1%Tipping retentions are standard; consequential loss exclusion can often be narrowed.Asia1.5 – 2.5%1%Tipping retention limited to specific deals dependent on underwriting.60Discussion: International Trends in RWI

61. Thank you61