88% of all deals required a split exchange and completion, continuing a long-term trend away from simultaneous exchange and completion. Funding requirements were the most common reason, in part due to the prevalence of debt funds in the market that commonly have longer drawdown periods than banks. The introduction of the new National Security and Investment (NSI) Act in the UK in January 2022 has also commonly been seen as a condition precedent, being included on a similar number of transactions to those requiring merger control and regulatory approval in 2022. As the NSI Act has no de minimis exemptions, unlike many merger control or other FDI regimes, the impact was seen on transactions across all enterprise value levels, particularly as buyers have taken an understandably cautious approach on making voluntary filings under the NSI regime.
88% of transactions required a gap period between signing and completion in 2022.
Walkaway rights between exchange and completion other than for non-satisfaction of a condition precedent remain very rare. Where agreed, these are typically linked only to specific business risks rather than for general material adverse change.
Only 7% of transactions had business warranties repeated on completion, and across all of these transactions, we saw no buyers with an ability to walk away from the transaction or to renegotiate the price based on matters disclosed prior to completion. Although buyers can obtain an enhancement under their W&I policy allowing them to claim in respect of items that arise in the gap period but are not disclosed prior to completion, they will in practice obtain relatively little value from a risk allocation perspective from repetition of the warranties. The general position therefore remains that the buyer takes on business risk in respect of the target with effect from signing of the SPA.
The COVID pandemic resulted in fewer processes being run as auctions in 2020 and 2021, but 2022 saw an increase to 61% of processes run as auctions, the highest we have seen since 2019, showing a return to a "business as usual" market, at least in the initial part of 2022. There were some indications that the Ukraine war and the impacts of inflation and rising interest rates were having some impact on how processes were being run in the latter half of 2022, but given the large number of processes that were already in train in the beginning of 2022, this has not yet been fully borne out in our data.
Use of auction processes returned to pre-pandemic levels of 61% in 2022.
Exclusivity was only granted on 48% of auction processes, a decrease from 57% in 2021. This reflected the seller-friendly nature of the market (particularly in H1) and, in a number of cases, the speed with which transactions were executed after receipt of final bids where a formal exclusivity period was not required.
Even during H1 of 2022 where conditions were largely seller-friendly, successful processes were heavily reliant on well-prepared targets and often a targeted pool of bidders who had been given time to understand the business before formal launch of the process. In processes with less well-prepared targets and less well-educated bidders, sellers tended to struggle to build competitive tension in the market, often despite the quality of the asset. This was a trend that became more pronounced as 2022 progressed. Effective sale preparation is therefore key, a trend that will inevitably continue into 2023.
Locked box remains the prevalent pricing mechanism for buyouts, being used on 94% of transactions, a significant increase from 79% in 2021. The majority of transactions have been constituted as locked box deals over the last few years, however highs of over 90% have not been seen since the mid-2010s, reflecting a return to more standard processes post-pandemic. During 2020 and 2021, the rush to deploy capital in a low interest rate environment, and extremely high competition for quality assets, led to investors seeking out more challenging investments, such as carve-outs and investments in jurisdictions where locked box transactions are less common. This led to a swing towards more completion accounts transactions. The changing economic environment in 2022 appears to have pushed investors to favouring more conventional investments, at least in the short term. However, there may be another swing in this statistic in 2023 if investors who have taken a cautious approach in 2022 and the early part of 2023 are faced with deployment pressure.
On deals using a locked box pricing mechanism, 70% featured an equity ticker, a slight increase against 2021's figure of 66%, and following a long-term upwards trend from 29% of transactions in 2018.
94% of buyouts used a locked box pricing mechanism in 2022.
Around 15% of deals in 2022 featured an earn-out, an increase on 7% in 2021 and 11% in 2020, and reflective of different consideration constructs used to bridge valuation mismatches, particularly in the second half of the year. 2022 also saw a return in the use of vendor loan notes as a form of deferred consideration, which had been rare in recent years. This was not surprising in the context of a more difficult debt financing market, both in terms of availability of capital and, where available, pricing.
W&I has undoubtedly become a well-established part of the M&A market in the last few years, and featured in 88% of all transactions in 2022 across the full range of deal values, a sharp increase from 52% of all transactions and 78% of transactions over £100m in 2021. This increase is due to a combination of ever-increasing understanding of the product for both sponsor and trade buyers and the freeing up of the W&I market, which saw heavy capacity constraints amongst both brokers and underwriters following the upsurge in transaction levels after the initial pandemic slump, particularly in Q4 2021. Capacity seems to have returned to normal levels in 2022, allowing for W&I prevalence to be well and truly re-established and we expect to see similar levels of W&I usage in 2023.
On transactions where W&I was purchased, the vast majority (83%) had a £1 cap, or other nominal liability for the warrantors or the sellers – a slight decrease on 2021 (84%) but still a significant upward increase on 2020 (55%), reflecting a longstanding trend of liability caps for sellers reducing as the W&I market has matured. It is interesting to note that the more buyer-friendly market in the second half of 2022 did not dampen this trend.
The average excess for W&I policies taken out in 2021 was equal to 0.5% of enterprise value, which is flat with previous years and equal to the minimum which insurers were typically willing to offer until recently, albeit that an excess of as low as 0.25% of EV is sometimes available now, occasionally on a "tipping to nil" basis where loss exceeds the agreed excess.
Premiums in 2022 averaged approximately 1.50% of the sum insured in the UK, an increase from the 1.17% figure seen in 2021 and 1% seen in 2020.
In the context of a £1 cap, the warranty limitations are less significant but there are still trends worth noting, by reference to how they tend to interact with the W&I policy.
The most common claims threshold (being the financial threshold which warranty claims must exceed in order for financial recovery to be permitted) continues to be 1% of enterprise value, although 0.5% of enterprise value was a close second, typically matching the excess under the W&I policy.
The most common de minimis (being the minimum amount of any claim to be permitted or permitted to count towards the threshold) continues to be 0.1% of enterprise value.
Threshold and de minimis statistics have been relatively static for a number of years, but are increasingly reflecting the lower percentages of enterprise value available in W&I policies. This is reflected by the increasing prevalence of 0.5% of enterprise value thresholds, which previously was rarer.
12 months (as against the warrantors) remains the most common limitation period for general warranty claims in 2022 as it also was in 2021, having overtaken the 24 month period from 2020. This reflects the increase in insured deals and that it is now standard to extend the limitation period to a more usual 24 to 36 months under the W&I policy.
For tax claims, seven years remains the most common limitation period, but on insured deals it is now more typical for lower periods to be agreed, with the time period extended to seven years under the W&I policy.
72% of transactions last year featured a "blanket awareness" qualifier applied to business and tax warranties, a significant increase from 48% in 2021.
On transactions where a blanket awareness qualifier is included (or indeed any transaction where some of the warranties are qualified by awareness), it is possible for a W&I policy to include a "knowledge scrape" enhancement (typically for an additional premium). For the purposes of the policy, some or all of the warranties which are qualified by the awareness of the warrantors will be deemed not to include this awareness qualifier. In almost all cases with a blanket awareness qualifier, a knowledge scrape was included under the W&I policy.
Tax covenants were seen on 79% of transactions, slightly down from 83% in 2021 but largely in line with the upward trend since 2015, particularly for transactions over £200m which saw 84% include tax covenants, and 90% for all transactions run as auctions.
For larger transactions, these were all subject to a £1 cap on liability, supported by W&I insurance. It remains unusual on buyouts of mature businesses for sellers to stand behind unidentified historical tax risks.
Tax covenants were seen on 79% of transactions in 2022.
Restrictive covenants are typically included in sale agreements, shareholders' agreements and service contracts. To be enforceable, restrictive covenants must be reasonable in their scope and duration.
In the UK and Europe, unless there are compelling reasons to justify a longer period (e.g. in IP heavy businesses where the covenantor would have the ability to seriously harm the business of the target by competing with it), 24 months is generally the longest period that is enforceable in a sale agreement. This is also the most common duration seen during 2022.
It remains rare for financial sponsors to agree to comprehensive restrictive covenants, although we have seen some financial sponsors willing to give non-solicitation restrictive covenants in sale agreements in respect of key members of executive management. The scope of these tends to be deal-specific, but rarely covers more than a handful of individuals.