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The Complexity of Compromise; Choate, Hall & Stewart attorneys Lee Feldman and T.J. Murphy discuss ways buyers and sellers are bridging the valuation gap and identify potential pitfalls.

Article Excerpt
Byline: Lee S. Feldman and T.J. Murphy

The decline in private equity activity over the last year has been well documented. Even the most successful funds face difficulty accessing credit in amounts and on terms that are considered acceptable, which in turn creates downward pressure on valuations. Similarly, sellers of attractive companies do not feel compelled in a down market to sell businesses they have spent many years building, especially at Ebitda multiples below historic norms.

As a result of these conditions, buyers and sellers devote significant time exploring transaction structures capable of bridging this valuation gap. Some of the devices that buyers turn to include seller financing, earn-outs, creative equity sharing arrangements and credit enhancements. While much has been written about seller financing and earn-outs recently, creative equity arrangements and credit enhancements have garnered less attention, but can be useful tools to help mitigate the associated business and legal risks for buyers.

During the boom years, private equity sponsors financed acquisitions with as little as 25% equity and the balance with third-party senior and subordinated debt on attractive terms. Private equity funds now must fund a greater portion of the purchase price with equity, which puts significant pressure on returns. A corollary of this is that many funds now require sellers to retain, or "roll over," a greater portion of their equity as part of a sale....

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