Financing Conditions in M&A Acquisition Agreements

Posted on 06-03-2016 by
Tags: Industry Insights & Trends , mergersacquisition , LIT , M&A , LPA

 A financing condition (also known as a “financing out”) in an M&A acquisition agreement provides the buyer with a right to terminate the transaction (commonly known as a “walk right”) in the event that that the buyer is not able to secure financing to fund the acquisition. Traditionally, financing conditions have most commonly been employed by private equity buyers in leveraged buyouts where a substantial portion of the purchase price is borrowed.

By execution and delivery of an M&A acquisition agreement, a buyer commits to, among other things, deliver the purchase price and other closing consideration to the seller at closing. Where the buyer does not have sufficient funds on hand to finance the transaction, it must borrow funds to meet that obligation. Absent modification by the terms of the acquisition agreement, the buyer bears the risk of changes that might occur to the terms and availability of financing during the interim period between signing and closing. A financing condition reallocates this interim period risk by permitting the buyer to terminate the acquisition agreement if, at closing, financing is unavailable or available only on unfavorable terms.

At a high level, there are two main types of financing conditions: strict financing conditions and financing failure financing conditions:

  • Strict financing condition. A true (or “strict”) financing condition is the traditional mechanism by which financing risk is reallocated for the benefit of the buyer. This type of financing condition most closely resembles a “pure option” allowing the buyer to terminate the acquisition if it does not obtain acceptable financing sufficient to fund its obligations under the acquisition agreement (e.g., purchase price, any obligation to fund initial working capital requirements, transaction costs, etc.). What is “acceptable” is traditionally left to the buyer’s discretion, although various limitations can be imposed in order to reduce optionality. Strict financing conditions are very rarely employed by sophisticated players in today’s market, particularly in competitive auctions where certainty of closing is second only to purchase price in importance when assessing a bid. Where employed, a strict financing condition will often be coupled with a reverse termination fee, which functions like an option exercise price. 

  • Financing failure financing condition. This type of condition is the most commonly employed mechanism by which modern M&A acquisition agreements reallocate financing risk. In this type of provision, the buyer retains the right to terminate the acquisition agreement in the event that financing becomes unavailable but this right is conditioned upon compliance with certain covenants of the buyer related to the financing. Specifics vary from one transaction to the next, but generally this type of mechanism restricts the buyer’s right to terminate the acquisition agreement to situations where previously secured financing (the terms of which are made known to the seller) falls through (i.e., “fails”). It will also often obligate the buyer to make certain efforts to enforce its rights under such financing. Sellers are generally granted a degree of specific enforcement rights to force buyers to secure financing and/or close the transaction, and are granted a reverse termination fee where financing is truly unavailable.

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For additional information on financing conditions, and coverage of a host of transactional law topics, click here to visit Lexis Practice Advisor. 

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