All-equity deals are gaining traction among mid-market PE firms, according to a new survey from law firm Katten Muchin Rosenman.
The deals, Katten said, “require buyers to fund the full purchase price of a company if the debt is not available by the closing date.”
However, the standard is for buyers to take on debt for their purchases after closing, Katten partners told Private Funds CFO in written statements.
Competition as a driver
Katten said jostling among prospective buyers may be responsible for the rise in all-equity deals.
“A competitive M&A landscape appears to be fueling a rapid shift to all-equity deals,” the report stated.
Competitive bidding can be influenced by three factors, Katten partner Kimberly Smith explained in a written statement.
“In a competitive auction situation, sellers choose the winner based on price, certainty to close and speed to close,” said Smith, who is also global chair Katten’s corporate department. “If one bidder has a significantly higher price than the others, then that bidder’s certainty and speed to close may not matter.”
Smith added that non-pricing factors can prove crucial in certain cases, explaining that “in an auction with multiple bidders around the same price, speed and certainty to close can be a differentiator that helps to win the deal.”
In these cases, all-equity bids are differentiators because leverage comes with uncertainty and risk, Smith noted.
“Making debt financing a condition to close can add time, complexity and risk to the closing process,” she said. “By contrast, an all-equity deal means all funds are coming from the PE fund and so there is not that same delay, complexity or risk from a financing.”
Prevalence and risk
More than half of respondents (55 percent) said they’ve been involved in all-equity deals, either on the buy or sell sides, for a majority of their transactions over the past year.
Additionally, an overwhelming majority of respondents (76 percent) expect that all-equity deals will increase either “somewhat” or “significantly” in 2023.
A plurality (41 percent) also named all-equity deals as “key” for successful creating deals in the new year. Fund-term changes, and more protection between the signing and closing of deals, tied for second at 39 percent each.
The report also touched on how the deals carry their own risks.
“Respondents recognize that all-equity deals lean high-reward, low-risk today – but an element of risk is always involved in all-equity deals, and they stand to get riskier given recent changes in the debt markets,” according to Katten.
Asked about the risk profile, Smith attributed it to the sequence of bidders paying upfront and taking on post-close debt – particularly in a challenging credit environment.
“In that way, the sponsor is taking the risk that the deal can be financed,” Smith continued. “As credit markets tighten and debt becomes more difficult to obtain, the financing risk assumed by the sponsor in the all-equity deal increases.”
PE firms rarely forgo adding debt, Katten partner Christopher Atkinson noted in a written statement.
“Virtually none of them hold with all equity,” said Atkinson, who co-chairs the law firm’s practice for PE and M&A. “The debt leverage is crucial to get their returns.”
Sponsors don’t expect M&A decline
Most respondents expect that deal activity will either be flat or grow in 2023, Katten noted. The results show that 40 percent predict volume will be unchanged, 28 percent expect it to “increase somewhat” and five percent believe it “will increase significantly.”
In contrast, 23 percent expect M&A volume to decrease “somewhat” and 3 percent expect it to decrease “significantly.”
The firm noted that GPs’ own fundraising situations may explain the relative optimism despite multiple broader headwinds.
“The amount of dry powder that PE firms have on hand could be driving this disconnect – especially as an overheated economy, domestic policymaking and geopolitical tensions come to a boil,” the report said.
The survey, conducted during the fourth quarter of 2022, sampled 100 mid-market dealmakers at US-based firms.