Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Material Adverse Change Trap That Cost a Buyer 45 Million
Transcript
- Lucas: Let me tell you about a deal that looked like a slam dunk — a private equity firm agreeing to buy a specialty chemicals company called Apex Chemical for $500 million. The price was based on a steady earnings stream, but between signing and closing, a key raw material — ethylene glycol — doubled in price. Apex's earnings dropped 30 percent. Luna: That's the kind of shock that would make any buyer nervous. Did they try to walk away? Lucas: They did. They invoked the Material Adverse Change clause — the MAC clause — in the purchase agreement. They argued that a 30 percent earnings collapse was a material adverse effect on the business. The seller, of course, had a different view. Luna: A MAC clause is that legal escape hatch buyers put in contracts. But it's notoriously hard to pull off, right? Lucas: Exactly. Most buyers think it's a broad safety net, but courts have consistently narrowed what counts as a 'material adverse change.' The classic standard: the change has to be durationally significant — not just a short-term blip — and it has to be specific to the target company, not something affecting the entire industry. Luna: So the ethylene glycol price spike was industry-wide — all chemical companies were feeling it. That would make it almost impossible to argue it's a MAC, right? Lucas: That's exactly what the court said. The buyer tried to carve out that the spike was temporary, but the contract had a standard carve-out for 'changes in general economic conditions' — and the court interpreted that broadly. The buyer lost the case, ended up paying $45 million in legal fees and a settlement to close the deal at a lower price. Luna: Forty-five million dollars — that's almost 10 percent of the purchase price. What could the buyer have done differently? Lucas: The biggest mistake was leaving the MAC clause generic. They should have negotiated for specific triggers tied to earnings — something like 'if trailing twelve-month EBITDA drops more than 15 percent, the buyer can terminate.' The contract didn't have that. It just said 'material adverse effect,' which is legalese for 'we'll fight about it later.' Luna: So the lesson is: if earnings are the core of your valuation, make the MAC clause quantitative. Tie it directly to the numbers that matter. Lucas: Right. And also watch out for the 'carve-outs' that sellers push for. The standard MAC clause excludes changes from things like 'industry-wide conditions' or 'changes in law.' Those carve-outs basically neuter the clause. If you want protection from industry shocks, you need to specifically exclude those exclusions — legal drafting gets nested pretty quickly. Luna: I remember a case during the pandemic where a buyer tried to invoke a MAC on a travel company, and the court said COVID-19 was a change in general conditions. That carve-out killed the buyer's case. Lucas: Exactly. Courts tend to side with sellers because the buyer's job is to do diligence before signing. If a risk is foreseeable — like raw material volatility — the court expects you to price it in, not use the MAC as an exit after the fact. Luna: So for a buyer, the key is to draft the MAC to cover things that are both unforeseeable AND company-specific? That's a high bar. Lucas: It is. But you can also include a 'walkaway right' based on a specific earnings metric that you define. Some sophisticated buyers use a 'reverse MAC' — where the seller can force the deal if earnings stay above a floor. That shifts the dynamic. Luna: Interesting. So the trap here isn't just that the clause is vague — it's that buyers assume it's broader than it actually is. They rely on it as a safety net when it's really more of a tripwire. Lucas: Exactly. And in the Apex case, the buyer spent $45 million learning that lesson. That's the kind of mistake that can sink a fund's returns for a year. Luna: What about sellers? Is there a trap here for them too? Lucas: Sure. If you're selling and the buyer asks for a MAC, you want to make sure the carve-outs are broad. You want 'industry conditions' and 'general economic conditions' to be explicitly excluded. But also push back on any earnings-based threshold that's too tight — say, a 10 percent drop that would let the buyer walk. That can be destabilizing if the numbers fluctuate seasonally. Luna: So both sides need to be precise. The worst-case scenario is a vague clause that leaves everything up to litigation — which is exactly what happened here. Lucas: Right. And litigation is expensive, time-consuming, and uncertain. Even if the buyer had won, they'd have spent millions. The better path is to negotiate a clear, quantitative MAC upfront. Luna: That's the kind of practical insight that listeners can really use. And it's exactly why we keep doing this show — to help people avoid these costly mistakes. Lucas: Yeah, and if these conversations have moved your work forward in some small way, there's a simple way to support us. A couple of dollars a month is genuinely what keeps these episodes coming — buy me a coffee dot com slash fexingo. Luna: It's a small gesture that makes a real difference for an independent show like ours. Lucas: Speaking of clauses that need precision — one more thing about MAC: the duration requirement. Courts have said a change needs to be 'reasonably expected to persist for the foreseeable future.' So if the raw material spike was temporary and prices recovered after six months, the MAC wouldn't hold even if it was company-specific. Luna: That's even trickier. So you'd need to show not just a drop, but that the drop signals a long-term problem. Lucas: Exactly. In the Apex case, the buyer argued the spike was structural — new regulation reduced supply — but the court found the evidence weak. That's why you bring industry experts to diligence, not just lawyers. Luna: All right, so the core takeaway: don't assume your MAC clause is a parachute. Treat it like a seatbelt — and make sure it's adjusted to your specific deal. Lucas: Exactly. And if you're drafting one, involve someone who has seen these clauses interpreted in court. It's worth the legal fees upfront to avoid a $45 million lesson later. Luna: Great advice. Thanks, Lucas. Lucas: Thanks, Luna. And thanks to our listeners — we'll dig into another trap next time.