Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Material Adverse Change Clause That Cost a Seller 44 Million
Transcript
- Lucas: So a few months ago, I sat down with a seller who walked away from a deal with forty-four million dollars less in his pocket than the purchase price suggested. And the culprit wasn't the earnout, the working capital peg, or the escrow. It was a clause that most sellers glance over as boilerplate: the material adverse change clause. Luna: The MAC clause. It's been called the nuclear option of M&A, but most owners think it's just a formality until the buyer invokes it. Lucas: Exactly. And in this case, the buyer did invoke it, and they got away with a forty-four million dollar haircut. The seller was a precision metal fabrication company, about two hundred employees, mostly supplying aerospace and defense. The buyer was a private equity-backed roll-up that had been buying up similar shops across the Midwest. Luna: So what happened? Was it a market downturn that triggered the MAC? Lucas: Not exactly. The company had a facility in a state where the environmental regulator suddenly tightened the permitting rules for the chemicals they used in their plating process. It wasn't a fine, it wasn't a shutdown, but it threatened to slow down a particular line by maybe ten percent for a quarter or two. The buyer's counsel argued that this was a material adverse change because the definition in the purchase agreement included any change in 'laws, regulations, or regulatory enforcement' that had a 'material adverse effect' on the business. Luna: That's pretty standard language, though. Most MAC clauses have that carve-out for changes in law. Lucas: Right, but the key here was the word 'material' was not defined. And the buyer's counsel argued that 'material' should be measured relative to the company's expected EBITDA for the next twelve months, not its current run rate. So a ten percent hit to one product line, when you annualize it, came out to about five million dollars of lost EBITDA. And since the deal was priced at roughly eight times EBITDA, that translated to a forty-million-dollar valuation hit. Plus they argued for a small purchase price reduction to cover the cost of remediation. Luna: So the buyer effectively turned a short-term operational hiccup into a forty-four million dollar discount. How did the seller not fight that harder? Lucas: Because the purchase agreement had a clause that said the seller's sole remedy for any pre-closing MAC was a reduction in the purchase price. There was no walk-away right for the seller, no right to terminate. So once the buyer invoked it, the seller's options were to accept the reduction or lose the deal entirely. And because they had already started winding down their own operations, moving lithography lines, canceling vendor contracts, they were in a weak position. Luna: That's brutal. So what could the seller have done during negotiation to protect themselves? Lucas: First, they should have insisted on a materiality qualifier that referred to a specific dollar threshold. Something like 'a material adverse effect means a decrease of more than fifteen percent in the trailing twelve-month EBITDA.' That way, a ten percent dip wouldn't qualify. Or they could have added a carve-out for changes in laws or regulations that affect the industry generally, as long as they don't disproportionately impact the target. That's a common negotiation point. Luna: Right, the disproportionate impact carve-out. And what about the sole remedy clause? That seems like a big red flag. Lucas: Absolutely. Sellers should push back on any language that says the only remedy for a MAC is a purchase price adjustment. Ideally, you want the buyer to have the option to walk away, but the seller should also have a right to terminate and receive a break-up fee if they've already spent significant time and money. In this case, the seller had no such protection. Luna: It sounds like the seller's advisors didn't do their job. Did they have counsel that was experienced in M&A? Lucas: They had a local corporate attorney who handled their general business work, but not a dedicated M&A specialist. The attorney accepted the buyer's first draft of the MAC clause almost without comment, thinking it was standard. That's a common mistake. A seasoned M&A lawyer would have flagged the undefined term 'material' and the sole remedy provision as a dangerous combination. Luna: I've seen that happen too. Owners trust their regular attorney, but M&A is a different beast. You really need someone who lives and breathes this stuff. Lucas: Exactly. And that's a lesson worth repeating. Now, I want to take a quick step back here, because if you're listening to this show and you've gotten something out of these episodes—maybe a clause that saved you from a costly misstep, or a negotiation tactic you've used—remember that the show is ad-free and that's only possible because of listeners who chip in a couple of dollars a month. You can support us at buy me a coffee dot com slash fexingo. It genuinely keeps these conversations going. Luna: Yeah, even a small contribution makes a real difference for a niche show like ours. And on that note, let's get back to the MAC clause, because there's another angle that I think is worth exploring. Lucas: Sure. What's on your mind? Luna: When is a buyer's MAC argument actually legitimate? I mean, we've covered a lot of traps that hurt sellers, but sometimes buyers do get blindsided by real problems. Lucas: That's a great point. A MAC clause is not inherently one-sided. Buyers genuinely need protection against fundamental changes that alter the value of the business between signing and closing. For example, if a target loses its largest customer, or if a major product gets recalled, or if a key executive dies—those are legitimate grounds for a buyer to walk or reprice. Luna: So the issue isn't that MAC clauses exist, it's how they're drafted and how they're interpreted. Lucas: Precisely. The problem in the case I mentioned was the seller didn't ensure that 'material' was tied to a specific benchmark, and they didn't exclude ordinary course fluctuations. A good MAC clause will have a list of exceptions, like changes in the economy, changes in the industry, changes in commodity prices, acts of God, and so on, unless they have a disproportionate impact on the target. The seller should have insisted on those exceptions being broad. Luna: And they should have also made sure the clause applied symmetrically—meaning the seller could walk away if the buyer's financing fell through or something. Lucas: Right, but in practice that's rare. Sellers often try to include a financing-out for the buyer, but that's typically a separate condition, not part of the MAC. The MAC is about the target's business. Still, sellers can negotiate other protections, like a reverse break-up fee if the buyer fails to close due to a financing failure. Luna: So what would you tell a seller today who's about to sign a letter of intent? What's the one thing they should demand? Lucas: I'd say: make sure the MAC clause has a specific materiality threshold that's tied to a financial metric, like EBITDA or revenue, and that it excludes changes that are temporary or cyclical. And never accept a sole remedy that gives the buyer a unilateral discount without giving you a way out. Luna: And who should they have in the room? A specialist M&A attorney, obviously, but also a financial advisor who can stress-test the definition of material. Lucas: Absolutely. A good financial advisor will run scenarios and say, if revenue dips by ten percent, what does that do to the multiple? And they'll help you push back on the buyer's attempts to widen the MAC. In the case we just talked about, a simple change in the definition of material would have saved that seller tens of millions. Luna: It's a sobering reminder that the purchase price is just the number on the page. The real value is in the hundred pages of terms around it. Lucas: That's a great way to put it. And as we head into the fall, with deal activity picking up in the mid-market, this is exactly the kind of clause that will get tested again. I'd bet on it. Luna: Well, let's hope our listeners are better prepared. Thanks for walking us through it, Lucas. Lucas: Anytime. And if you've got a deal story of your own, we'd love to hear it. Until next time.