Surprise ... it’s better to be big. And more heft doesn’t just help in sports; it also matters when you’re selling your company. Any M&A lawyer will tell you anecdotally that transaction size impacts the terms of a negotiated acquisition. More money affects bargaining power and tends to gloss over smaller problems.
Now a new study (Rauch and Burke, 71 Business Lawyer 835 (2016)) confirms that negotiated terms become more seller-friendly as transaction value increases. The authors looked at five hotly-negotiated points* in most deals and found that across the board, as the dollar value of the deal increases, the more likely the parties are to settle on terms that are more seller favorable. For example, in every deal the seller wants to cap its potential indemnification liability risk to the buyers. The seller wants a lower cap and the buyer would prefer a higher cap relative to the purchase price. The authors found a progressive decrease in the size of the liability cap as deal size increased, implying that as the deal size grows, the buyers lose the leverage to force sellers to bear more transaction risk.
The data don’t offer any rationale, but the results suggest that the market for smaller deals is weaker and the buyer has correspondingly more bargaining power to force the sellers to “take it or leave it” on deal points. In larger deals, perhaps the massive cost and effort involved in mounting an acquisition team invokes the sunk cost trap (the more time and money invested in a project, the less likely one is to abandon it) in the minds of the buyers, making them more willing to acquiesce on significant terms in order to get the deal done.
Interestingly, this study looked at the largest sample of data in any published M&A study (almost 850 deals over nine years) and the authors’ characterization of deal sizes departs from most common usage. Many people toss around the term “middle market” with widely varying concepts. According to the authors, the middle market comprises deals ranging from $10 million to $1 billion. That’s a huge swath, and the $10 million floor probably makes some popular usage of the term pretty far off the mark.
In case you were wondering, of course size affects deal prices too. Seller valuations are often expressed as a multiple of earnings (EBITDA), and yes, as deal size increases, the multiple of earnings increases as well. See Are Values Commoditizing?, GF Data Resources (Feb 5, 2015).
*The deal terms reviewed were: liability cap, liability basket type and amount, sellers’ catch-all representations, the no-undisclosed-liabilities representation, and closing conditions.