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Q:
Why are so many private-equity deals blowing up? Alan
Engle, Great Neck,
New York
A: The
short answer is that the world has changed (read: the
US
sub-prime-mortgage mess has erupted). A lot of companies
that were once hell-bent on acquiring hot new properties
suddenly want out of deals that are starting to look too
cold for comfort.
It’s sort
of like those hours after the Titanic ran afoul of the
iceberg. The realists in the crowd didn’t exactly stroll
to the lifeboats. They bolted.
That’s
what you’re seeing now—and not just from private-equity
firms. Many companies, emboldened by the strong economy
and its abundance of low-cost credit, have spent the last
few years buying up every acquisition target with a pulse.
Along the way, dealmakers didn’t exactly ignore risk; they
just thought they’d be able to handle any form of
mishegoss, or craziness, later.
Well, it’s
“later” now, and dealmakers are starting to bail.
It’s
amazing that some can. Or at least, they can try—thanks to
MAC, the Material Adverse Change clause embedded in
virtually every merger-and-acquisition contract. Indeed,
in our view, what’s happening with MAC right now provides
an important, if wince-inducing, management lesson about
when a CEO should delegate the “details” concerning
significant risk—which is basically never.
Wince-inducing because it’s astonishingly easy to do
otherwise.
Imagine
yourself at the center of a deal being forged. Your team
started out the process by making the target company’s
team a “generous” offer of, say, $23 a share.
“Ridiculous!” was their retort. “We’re not going to our
board with anything less than $27.”
Then, for
the next slew of days, if not weeks, you wrangle,
begrudging each other $.50 at a time. Finally, after
negotiating every last provision of the financials, the
end comes into sight with a price of $25.50, right in the
middle with a little sweetener thrown in for the target.
And, no
surprise, it is
8 p.m. on a Friday night. So you and the other CEO shake hands, in
equal parts exhausted and exultant, and turn to the
lawyers. “Paper this up,” you both say, “and have it ready
before the market opens on Monday.” At which point, the
lawyers go into hyperdrive.
One of
their jobs is to come up with a list of all the things
that could go wrong between the announcement of the deal
and its close, like a major strike against the target
company or one of its big customers going belly-up. Such
an accounting of every possible “adverse change” is the
more straightforward part of the contract process, and
usually gets done without too much sound and fury.
The hard
part—the part that usually gets short shrift—is the clause
in the contract that defines exactly what would make any
adverse change “material,” that is, significant enough to
merit killing the deal.
Materiality is hard to nail down for several reasons, but
the main one is simply that the laws governing it are not
particularly crisp. That makes it very difficult under any
circumstances, let alone high-pressure ones, to put a fine
point on the meaning of the term.
Is it a
20-percent hit to earnings? Or a 15-percent decrease in
revenues? Who knows? And so, the lawyers usually end up
leaving the language vague enough for both sides to say,
“Well, OK. Good enough.”
Fast-forward, then, to an adverse change, like the
subprime crisis we’re in right now, and you understand why
so many companies are engaged in legal slugfests over what
their MAC clauses technically allow.
Sallie
Mae, the United States’ largest student-loan provider, and
the private equity firm J.C. Flowers could be in court for
years, for instance, as could Cerberus, the international
private-investment firm, and United Rentals, the world’s
largest equipment rental company. What a waste of time,
energy and money for everyone involved.
In time,
of course, credit will loosen and the economy will
recover, and when that happens, the details of any given
MAC clause will matter a lot less. But even then, there
will always be contracts with room for maneuvering and
mischief around their terms, if only because there will
always be dealmakers who would rather hedge their bets
than face the reality that, sometimes, MAC happens.
If the
current subprime mess teaches us anything, however, it is
that principals should stay with their deals through the
bitter end, sorting out of every last detail surrounding
risk. It’s grunt work, we realize, gritty, boring and
plain not fun.
But when
the stakes are high, you have no choice. Don’t delegate
the pain away.
*****
Jack and Suzy Welch are the
authors of the international bestseller
Winning (Collins). Their
latest book is Winning: The Answers: Confronting 74 of the
Toughest Questions in Business Today (Collins). They are
eager to hear about your career dilemmas and challenges at
work and look forward to answering your questions in
future columns. You can e-mail them questions at winning@nytimes.com.
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