Contributed by: Kurt Sarno, Rory ffrench, and Mariangela Asturi
M&A dealmaking in Canada has undergone a shift from the frenetic pace of 2020 and 2021 to a deceleration in deal volumes since then. The robust sellers’ market has shifted, at best, toward neutrality, partly due to increased leverage costs. Blake, Cassels and Graydon LLP (Blakes) recently published the fourth edition of its Canadian Private Equity Deal Study (Study), a proprietary analysis of hundreds of Canadian private equity buyout and investment transactions, which highlights trends that have evolved with the market’s shift.
The Blakes Study found certain industries remained resilient despite the slowdown, particularly technology and media, industrial goods and services, and life sciences, encompassing, respectively, 33%, 19% and 10% of deals. The Study reported “private plans of arrangement” being used more frequently to acquire widely held (principally healthcare and technology) targets, an increase in deal sizes, as transactions under C$100-million decreased to 43% from 50% in the third edition of the Study, and a consistent if not growing interest in Canadian targets from U.S. private equity buyers.
As the Study illustrates, various dealmaking terms also shifted in recent years. For example, the increased use of earnouts in 2020 and 2021 has since waned, despite uncertainty around valuations remaining. Similarly, the use of “no-recourse” or “public-style” deals, where the risk for damages relating to pre-closing periods is shifted from sellers to buyers, initially increased but has started to fall in recent years, which aligns with the statistics on the use of representations and warranties (R&W) insurance reported in the Study. R&W insurance premiums peaked at record highs at the start of the Study period, in some cases pricing the product out of certain transactions, before descending to historical values as dealmaking slowed. The Study also reveals that U.S. deal terms continue to influence Canadian transactions, with trends such as the inclusion of “fraud definitions”, which stems from Delaware case law, increasing from 29% of deals in 2019 to 50% in 2022.
The pace of change in Canadian tax law has also accelerated dramatically recently. The past few years have seen major new rules and/or proposed changes in the areas of interest deductibility, hybrid instruments, limitations on tax treaty benefits, transfer pricing, and several new mandatory reporting regimes, among others. The structure of transactions and the drafting of purchase agreements continue to evolve as the legal industry works to optimize transactions in the face of these new developments.
As noted in the Study, the leveraged credit markets have been increasingly impacted by two important issues. First, the tightening of risk appetites by leveraged lenders has made credit less available for leveraged borrowers. Second, with several major credits due in the coming years, the appetite for refinancing remains high. Together, this combination is making the availability of exit financing options somewhat limited. Risk appetites have resulted in reduced traditional take-out financing and Term B refinancing, with increased emphasis on more rigid credits, bridge financings, and amend-and-extends with the existing lender group (often with a margin step up).
The regulatory aspects of M&A transactions are also more frequently becoming top of mind for potential acquirers and sellers, as covered in the Study. Canadian regulators, both in antitrust and foreign investment, are generally looking at transactions more closely. Legislative amendments that were implemented in late 2023 or are likely to be enacted in early 2024 will impact regulatory requirements and affect deal timelines. The Canadian Competition Bureau (CCB) is more inclined to conduct in-depth reviews, particularly in industries that are consumer-facing. Merging parties will no longer be able to rely on an explicit efficiencies defence to mergers that are otherwise considered to be anti-competitive. Under proposed amendments likely to be enacted in 2024, the CCB will have three years post-closing (as opposed to the current one-year limitation period) to challenge even transactions that fall below the pre-merger notification thresholds and are not notified unless clearance has been obtained in advance. Under changes to the Investment Canada Act (ICA), a wider range of acquisitions and investments by non-Canadians are likely to undergo mandatory screening for national security concerns. Under proposed amendments likely to be enacted in early 2024, a mandatory pre-closing notification will be required for investments regardless of deal value in certain sectors to be listed in 2024. These amendments will also provide for greater penalties for contraventions of the ICA and provide greater powers to government officials to negotiate commitments from foreign acquirers to resolve national security concerns.
“What is market” in Canadian private equity will undoubtedly continue to shift as a variety of factors, including the volume of available capital, likely future reductions in borrowing costs, and narrowing valuation gaps, contribute to a rebound in deal volumes.